We multiply adjusted EBITDA by a multiplier to value a business
(for positive EBITDA businesses only)
Adjusted EBITDA x Multiplier = Enterprise Valuation
We start with EBITDA, defined as earnings before interest, taxes, depreciation and amortization, and adjust for any expenses that increase or decrease following a sale of the business to arrive at Adjusted EBITDA. Typical adjustments include (1) fair-value compensation for senior management, (2) fair-value lease rates for property, and (3) discretionary owner benefits such as personal automobiles, personal travel and non-active family member compensation.
A multiplier is selected based on a variety of factors, including: (i) sales growth rate, (ii) gross profit margin, (iii) Adjusted EBITDA margin, (iv) absolute size of Adjusted EBITDA, (v) required annual capital expenditures, (vi) required annual investments in working capital, (vii) customer concentration, (viii) breadth and depth of management, (ix) competitive landscape and (x) industry trends.
We assume the seller will pay off any outstanding debts of the company at closing. We also assume the business will be sold with the required amount of net working capital to operate the business. Working capital includes accounts receivable, inventory, prepaid expenses, accounts payable and accrued expenses. We do not pay extra for working capital and fixed assets on top of the value derived from our multiple-based approach.
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