Whether we are talking about a Fortune 500 company or a middle market enterprise or a main street business, most financial analysts will say there are three fundamental forces that affect a firm’s value: 1) what’s happening with the market as a whole, 2) what’s happening with a specific industry, and 3) what’s happening with the specific company.
In our column, we’ve harped on the last two. We’ve told you that you need to understand what the average company in your industry looks like and what the “USDA Prime” company in your industry looks like. We’ve told you that you need to understand how your firm will be seen by the “USDA Prime” buyer -- there are eight disciplines within a business that will be examined during due diligence.
Turning to the marketplace as a whole, a while back, we talked about a valuation market cycle that affects the middle market. And, we said that valuations would likely peak and then turn in 2018. Well, it appears that this might have started.
As a matter of reference, according to one data provider, middle market firms being purchased by private equity funds over the past 15 or so years have seen these average multiples:
| Revenue | EBITDA Multiple |
| $10 to $25 million | 5.6X |
| $25 to $50 million | 6.3X |
| $50 to $100 million | 7.2X |
| $100 to $250 million | 8.0X |
As an aside, we’ve suggested to you that one way to bump your own multiple was to acquire another firm. For example, your $20 million revenue company might achieve a multiple of 5.6 times EBITDA. Acquire another firm with the same revenue for the same multiple. The combined business of $40 million revenue will be valued at 6.3 times EBITDA -- expanding the multiple of both your unit and the acquired unit.
Back on point . . .
Over the past few years, valuation multiples moved up to significant premiums to those mentioned above. As it seems with the publicly traded stock market, people think that it is simply going to continue. After all, stocks go to the moon don’t they? (Check out NVDA.) And, when the inevitable correction comes, people get pushed out of shape . . . and the talking heads on the various television networks stir up the fear and (mess) with your emotions.
As was mentioned above, there is a multi-year valuation cycle with middle market firms and it appeared that 2018 would be a turning point. Well, the data is in and it appears that valuation multiples have started to break down. From 2017 to 2018, the average multiple of EBITDA paid for $10 to $25 million revenue firms dropped by a whopping 0.5X. That’s just about a 10 percent decline in prices paid. And, for this range, the multiple is only slightly above its 15-year average. During the same period, firms with revenues of $25 to $100 million held their own. But, firms with revenues over $100 million also saw a contraction -- approximately 0.3X EBITDA.
The year 2019 will be interesting to watch to see whether the stutter in 2018 was just an interim correction or is indeed breaking down as part of this long-term cycle. Whichever it is, you have the power to counteract it via actions within your firm -- those eight disciplines. You must decide on whether you are going to sell a USDA Prime company or a USDA Select company. Be honest with yourself. And, whatever you decide, as Coach Lombardi said, it can’t be a sometime thing . . . it has to be an all-of-the-time thing. Bo says Just Do It!
