28 Feb M&A Multiples based on Company Size
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Mike Harvath 00:04
Hello, this is Mike Harvath, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington, Minnesota. With this week Shoot the Moon podcast. With me this week is my partner, Ryan Barnett. Ryan, welcome.
Ryan Barnett 00:20
Hey, good morning, Mike. Thanks for having us on today. It’s been a good good start to the year and get things rolling, had some great podcasts that we’ve done this year so far. So if you’re new to the program, check, some of our latest ones out have been talking a bit about hiring the right salesperson and talking a bit about deal structures. And today, what we’re going to be talking about is a question that we get really a lot on both the buy side and the sell side of our work, which is when you’re talking about enterprise value, what size do you start to get some leverage on increasing the size of that enterprise value? We’re going to dig in a little bit today about the size of companies, some revenue and EBITA thresholds. But also take a look at how deals are shaped up in the IT services world. And for those who are new to this podcast. We are the world’s premier industry advisor for m&a For IQ services companies. So we work with a lot of managed service providers, application integrators, application developers, cybersecurity firms, and firms that are tech enabled in general. So today, Mike, I’d love you to just start out with when you look at a deal that’s traded in IT services today. No, how is that deal typically made up? Is it a multiple of what?
Mike Harvath 01:44
Well, deals are typically made up over multiple a cash flow or EBITA. At least in our world. That’s how it works. I think, you know, there was a time in our industry, whether that be for SaaS companies or you know, even certain classes of IT services companies or managed companies, that you sometimes get into a thinking about multiples of revenue, regardless of profitability, you know, we think those days are gone. And they probably were never even here for small tech enabled services businesses, you have to sort of walk a mile in the shoes of the buyer, which is, they’re always going to be looking for a return. And that return comes from growing predictable cash flow, and certainly proving that it’s there and that it will stay there is paramount to getting a premium valuation for your business when it’s time to sell.
Ryan Barnett 02:33
To recap that, typically, we’re not seeing deals traded on a multiple revenue.
Mike Harvath 02:39
Yeah, maybe in the equation, if you’re really high he even at right, so just think of the logic of it. You know, if you’re 20 22% 23%, even, you know, by nature, there’s going to be a deal that is going to come down based on that multiple of that, even though that is a multiple of revenue, typically, right? Just make sense that it’s going to be above 1x revenue, it’s gonna maybe it can be as high as two or two and a half times revenue, sometimes three times revenue, depending on the deal. In the deal, multiple EBITA. You should also know what confuses it even further is that, you know, most deals are private to private deals. In particular, the specifics of that deal are not reported in the public press. So there’s the terms of the deal were not disclosed, or, you know, there is no specific reference. If there is a reference, sometimes there’ll be a reference as a multiple of EBA. But only from a reference perspective, it doesn’t mean that you can translate that to other businesses, because you’re blind to the EBITA of that business. So the index value, the point that’s important to understand is that, you know, the value creation comes with a multiple of your profit or EBIT earnings before interest, taxes, depreciation and amortization. And, you know, there’s certainly, we’re gonna unpack a little bit in this podcast about where the thresholds for where to get more or a higher multiple of EBIT are based on size.
Ryan Barnett 04:05
I’d say one note to that is that when you think about EBIT, it typically is a an adjusted EBIT da, based on expenses that would not continue ongoing in the firm. So for example, if you had above market compensation, that may be added back to profit to bring that EBA to a level that’s perhaps higher than your your net income plus your taxes plus your debt plus your M jurisdiction. So there’s some allocation for add backs. It’s, the less I’ve actually have, it’s easier for someone to understand but it may increase your EBA there as well. When we look at deal structures and the multiples that are associated with it. Mike, I’d love to get your perspective on what categories of ranges that a buyer may be looking for within a seller. Let’s let’s just start with revenue and profit range are firms are you looking at something like sub 5 million 5 To 10, 10 to 20. How many understand the typical ranges that we’re seeing are bands of ranges?
Mike Harvath 05:11
Yeah, where buyers are interested in acquiring Ryan, is that the question?
Ryan Barnett 05:15
Correct, or even just how firms are categorizing themselves. So we certainly see that, for example, we typically do not see a maturity in a firm that has less than four $4 million in revenue. So for us, that’s a pretty small firm doesn’t mean that you don’t have the sale, but it may be just generally smaller, is there bands that start to make sense on is it below five, between five and 15, and 50?
Mike Harvath 05:46
So for firms really under 4 million in revenue, in order to really transact a deal, you have to be, you know, pretty profitable, doesn’t mean deals aren’t happening. But to be attracted to a buyer, it’s typically a strategic buyer, there’s got to be a strong and compelling reason to do that deal. And you have to be pretty darn profitable, which there’s plenty of firms that are below 4 million revenue, they’re pretty profitable. When I say pretty profitable, I’d say north of 15% EBITA. And certainly higher is better, you know, up to the 20 23% EBIT, arrange, you know, when you start to get firms that are over 5 million in revenue, and have, you know, EBIT as that are, you know, as a percentage north of 10%, for sure. And again, more is better and value creation terms start to get more interest by either larger strategics, or even some private equity firms, private equity firms usually started to get interested at a minimum of a million and EBITA. And usually more like a million and a half and even up. And so there’s certainly plenty of financial buyers that are interested in buying firms that, you know, our 3 million in EBIT and above. And when I say financial buyers are typically private equity, they’re looking to either add on to a platform or build a platform. And oftentimes we have conversations with private equity and say, Hey, we really like a firm, that’s over 5 million in EBITA up because wanted to play some cash, but they’re just attracting more buyers, as you go up the food chain from a profit perspective. I think, you know, likewise, there’s multiple accretion, there’s all kinds of interest in this conversation around, you know, where do we begin to get to higher multiples in a deal? And it’s a difficult question and answer, because depends a lot on your sub sector in tech enabled services. You know, are you a managed service provider? Are you a reseller with managed services capabilities or services that you know, are less than they 40 or 50% of your revenue? Are you a application implementer some of the implements, you know, Salesforce or ServiceNow, or while Microsoft products, or you custom developer, digital transformation business, already a SaaS business. In all of those situations, we are looking at businesses that had different types of multiples, and it’s just because of what’s commanded in the marketplace. So it’s hard to just paint the painting with a broad brush, right, you need to have the subtlety of the type of sub specialty technical service business. So you are in order to have an accurate conversation. And that’s probably the reason why, you know, you want to engage in advisor or valuation company, when you really want to try to get to what is your true valuation. But in general, you know, taking that into account, you can begin to look at multiples of EBIT a change, probably thresholds of at least a million and EBIT, uh, and then probably, again, at 3 million in EBIT, uh, and then again, you know, five or 6 million and Eva and then a 10 million in EBIT up, and then there’s those over 15 million in EBIT, uh, and again, this is profit, not revenue. So as you think about what has been occurring in that situation, there’s an argument to be made that, obviously, the more of the EBITA, the higher the multiple. And if you put together a few firms, and we’ve seen a couple of companies that have done this pretty successfully, in IT services, where they’ve come together, in order to create a firm that has a greater, even more value, you know, merges multiple companies and you know, merger, for example, a four companies, we can think of one in Minnesota that was very successful. So there’s certainly opportunities to do that. And I know many of you are listening to podcasts have conversations like that all the time you talk to a peer group or other members in the market and you say, you know, if we put our combined forces, we could get to a higher EBIT on multiple, I think that’s generally that statement is generally true, but you have to be sensitive to sort of where the thresholds are, you know, kind of in this 1 – 3 million 5 – 6 million 10 – 15 million ranges.
Ryan Barnett 09:48
And I’d say Mike, some of this just depends on the number that a person is looking for upon their exit. So sometimes if you’re gonna grow in the firm for so much, and you’ve capped out your EBITA, and that you Business remained steady over a few years, you still may want to sell but understand that if you’re under that million dollar threshold, you’re even a multiple is going to be less than than a tire. That being said, we’re still seeing even a, it’s not like if you’re under a million and EBIT, EBIT as your multiples can be Forex. Is that Is that a fair statement? Mike, can you tell me a little bit more insight on maybe perhaps that, that smaller range just to dig into this?
Mike Harvath 10:28
Yeah, that’s absolutely true. So there’s, there’s intangible, you know, situations that could drive up value. So you can’t, as I said, you can’t paint the picture with a broad brush, you know, the history of the revenue growth and profit growth, the value of the business strategically to an acquirer for a variety of reasons, right, you know, maybe a line extension? Or, you know, is it a services extension, same type of services? Is a geographic expansion sort of mandate, you know, is it more of a staff play, you know, the need to hire people in a certain market. And, you know, the additional revenue and profit and customer bases is a bonus, there’s a lot of things that can drive the multiple and drive value. And so it’s not as simple as just saying, Hey, if you’re under a million bucks, it’s a number. It’s not that but the biological translation is that as you move up market, and EBITA, you get more buyers that are interested, and more competition. And so there’s that component as well, that that really may not be part of the equation, if you’re, you know, company that’s under a million and even getting me and I get a hugely competitive sort of number of buyers that are frothing at the mouth to, you know, look at your business and acquire it, where our experience has been that as you continue to move out market, there’s more and more potential buyers that come out of the woodwork to look at the business and, and that competition does create upward pressure on the EBITA multiple.
Ryan Barnett 11:53
Mike, do you want to cover you know, ranges that we’ve seen, and some of these bands?
Mike Harvath 12:00
I will tell you that it varies widely, like I mentioned before, and it varies by your sub discipline and IT services. But to give you some, you know, broad brush strokes, you know, these deals under a million bucks and EBITA, you know, are typically and I could say they could vary as wildly as four to eight times, we’ve certainly seen depending on the value, maybe four to seven times four to six times as much more common, when you start getting over a million bucks. And even, you know, we started to get to, you know, values that could be six to eight, six to nine times, we get over 3 million in EBIT us probably approaches 12 times at the top end, kind of anywhere from eight to 12 you get about 5 million in EBIT, uh, you know, it could be, you know, tick even higher. And as you start to get into the 10 and $15 million, and EBIT arranges, those deals can get as high as mid high teens and even a multiple, again, it depends on the buyer, it depends on if it’s a creative to their value. You know, oftentimes, when you’re talking about firms that are 10 million or more and EBITA, the buyers really only fall into a couple categories. And those are private equity funded, sort of roll up place, or oftentimes, they’re public companies, certainly, there’s private companies that are big enough to do those deals. So I don’t want to excuse that, but oftentimes are a public company that as long as the deals are created up to their stock price, and everything else lines up, you certainly can expect, you know, higher types of multiples there.
Ryan Barnett 13:31
If someone has received capital, and has taken some kind of investment, and it may be at a, whatever multiple that may be, does that change the equation on the Exit Multiple?
Mike Harvath 13:46
I think it comes back to a question about, you know, how does private equity make money, right? I mean, they, they make money ultimately, when they buy the company and add value to it over time and then exit. And the expectation certainly will be to optimize that investment on the exit. So yes, the expectations of that investor have to be met. There’s timing expectations, as well as multiple expectations when they go into the transaction. So I think it’s important to note that and understand if you’ve accepted, you know, outside capital, you know, and obviously, if you’ve been down this road with a capital provider, you know, you know, these lessons but the point being that, you know, the expectations on investor will drive whether the timing of your quote unquote, second bite at the apple or your exit, and it will drive the type of offer that they will accept pursuant to their return expectations.
Ryan Barnett 14:39
And in speaking of that second bite of the apple, oftentimes we hear sellers that say, I just want to wait till I get to a certain number. And this could be that they’re less profitable today than they forecast in the future. Or it could be that there is an absolute size number because they What we’re talking about today that the larger the firm, the more likelihood of a higher multiple, there could be. Mike should should firms wait to hit a certain level to threshold, before they consider going to market?
Mike Harvath 15:16
A couple things I would think about, certainly, if you’re going to optimize value in your business, you want to be in the top quartile of your peers for EBITA. Generally, that’s about 15%, even though and tech services firms or above, and the higher the percentage, the better, frankly, and so I think you have to be cognizant of that, if you’re single digit EBIT a company, you’re not going to be able to optimize value your value very well, doesn’t mean you can’t transact a good deal, or one that might, you know, make sense for you for variety reasons. Because not all the reasons to sell our financial, right, or think about a transaction or financial. So you have to take into consideration all those things. But certainly, you know, you need to be in double digit multiples, Anita and I would recommend probably over 15%, I would also say that, you know, in general, you want to try to be above a million bucks on EBITA, you know, that, that you’re gonna have more buyers that will look at the deal above a million bucks, and even then you well below that. And likewise, they’ll have more than a look at 2 million or 3 million. And so the more buyers, you can get looking at the deal, the more competition and ultimately, the higher the number, I think, you know, another factor has to do with sort of balance in your life, you know, timing, where you are in the business as relates to passion, and focus. There’s just a lot of variables that come into play. So, you know, these are general guidelines, rules of thumb, but certainly not, you know, I wouldn’t talk you out of doing a deal. If you were a half a million dollar and EBIT a company that felt now’s the time, you just need to understand that being in these bands of have consistent growth year over year, being above 15% EBITA. Uh, and being a firm that’s above 4 million in revenue, I certainly will help things move things along as it relates to interest.
Ryan Barnett 17:09
To just reiterate your point, there’s so many factors that deal just this, the piers, absolute size of your firm is only one one consideration. No deal gets done unless there’s a strategic fit and a cultural fit. And if there’s not there, you know, you’ll never be talking these kind of multiples. But it is important to understand the makeup of your revenue, the makeup of your the category that you’re in, has tremendous impact upon a multiple profitability in your profitability rates and your ability to execute well starts to play play a day and night in the eyes of an investor. So focusing on becoming a high profit firm, with a great growth rate helps to bring more suitors to the table. And a lot of this, again, goes back to what’s in your mind for the appropriate number. A number that you may have in your head today could be achievable if you take a different approach at structure. And, Mike, I guess the last question I have for you today is today we’ve thrown up a few multiple ranges, is that the total enterprise value? Or is that a cash related deal? Or is that what kind of structure would someone are those ranges appropriate for?
Mike Harvath 18:30
Those are total for total enterprise value? I mean, I think again, every deal is different, right? Some deals are all cash on deals are. And typically they’d be on the low end of the range, some are all variable. And what I mean by that they may be consist of a vendor, take back seller note, they may consist of what we call equity rollover, where accepting equity in the other business. You know, for a future kind of benefit, you become an owner in the new business, I’ll be at a smaller percentage, then I’ll be on your business. But you know, there’s equity rollover, there’s earn out if you will, or gain share agreements where you have to hit certain performance thresholds. And if so, you get paid at those levels of certainly a lot of different kinds of consideration that goes into enterprise value. And we’ve recorded a few other podcasts on this topic that are encouraged you to go listen to.
Ryan Barnett 19:21
Yeah, I think it’s important to understand these multiple ranges are, we’re seeing them out there in the market, but there’s so many variables that come with it. When you’re taking a look, the enterprise value may have someone that comes back and says here’s a 15 times EBIT, uh, but it may be 90% on gains here. So, be careful on the structure that you pick and understand that there are certainly going to be levers that are pulled and the more cash you see in front, you may have a lower multiple that comes with that deal. Well, Mike, appreciate the insight here today. To recap, the larger the EBITA richer, the EBITA multiple, that’s there, there are some that’s a threshold. So if you’re over that million dollar mark, it’s going to be more favorable. If you’re over that three to five, you’re going to start to see some, some larger optics in that multiple. Understand that it’s good to always keep your firm ready for a process. Even though you may not sell, it’s unreal to understand the marketplace, the trends and the multiples that are out there is critical for the long term success for yourself and your personal and company goals. And then if you’re to a point where you are considering a sale the to either combine other businesses and understanding your own acquisition power could ultimately lead to a combined event that is higher for everyone, which could lead to a higher multiple upon that higher up. So getting the most higher thresholds could lead to a larger exit for everyone involved. That being said, again, if a deal doesn’t isn’t done strategically, and culturally, you’ll never be done financially. So before you even engage in any of these multiple discussions, it’s critical that that fit is established, and I need an advisor is that the best way to help establish that Mike, I’ll be with you with any closing thoughts.
Mike Harvath 21:22
Yeah, I think you’ve covered it well, Ryan, I think we’re certainly happy to discuss this topic further with you. Drop us a note and info at revenue rocket.com Or find more details about our thoughts on this on our website. And revenue. rocket.com are tuned into a variety of different topics that’s around multiples and m&e and value creation through our podcast series. So with that today, we’re going to tie a ribbon on it for this week. Make it a great week. We hope you tune in next time. Thanks a lot. Take care