EBITDA multiple (Enterprise value concept)

Company valuation based on EBITDA multiples is a seemingly simple, straight forward method, requiring only a limited amount of data, using a simple formula with a user-friendly interpretation. Thanks to these attributes, the counterparts are relatively quickly able to agree on the inputs, calculate the company value and interpret the final result.

It is a very common occurrence in our daily business life that we meet with our clients, which have a clear idea of what their company value is, even before any detailed valuation has been performed. Some have already began negotiations based on their estimate of company value. Whereby, the company value is predominantly based on their

interpretation of the EBITDA multiple method.

Often, the valuation uses misinterpreted inputs, calculation formula or the final value. Based on these misinterpretations, a seemingly user-friendly valuation method creates an uncomfortable situation in which on transaction side or the other (sometimes even both) realize that, due to these mistakes, there are material differences in the final value interpretation and that they must reopen the transaction price negotiations.

What does the term „EBITDA multiple“ mean?  – there are many local as well as international sources, which collect and subsequently distribute the M&A transactions data, whereby they use the term „EBITDA multiple“ as a company/transaction comparison criteria.

The EBITDA multiple ratio is, based on the industry standards, a result of the EV/EBITDA calculation formula, which means that it consists of EV (company Enterprise value) and of EBITDA indicator. This is due to the standardized use and reporting of the Enterprise value within M&A transaction by the involved parties. This value is subsequently being entered in the publicly available databases. Let us take a closer look at these EBITDA multiple calculation inputs as well as their most common calculation and interpretation mistakes:

I. The difference between the equity value and company enterprise value

Enterprise value is the total value of a company, representing the amount, which an investor would have to pay to the owner of the company equity as well as to the providers of company debt. It does not represent only the value of the company equity. Simply put, it is the net amount that the buyer would have to pay in order to „pay out“ of the company both the shareholders and the financing banks.

For illustration, here is the simplified formula for Enterprise value calculation:

Enterprise Value =

+ value of the owner`s equity,

+ market value of interest-bearing debt,

- free cash and cash equivalents.

The amount of cash is substracted from the final value as it it being assumed that some of the interest-bearing company debt may be settled with the company cash itself.

Let us use and example:

A renown resource provides transaction details on the sale of 100% share stake in the company MARWIN at a reported Transaction value, meaning Enterprise value = EUR 5.250.000. From the same information resource, we are able to read the following financial data:

EBITDA = EUR 700.000,-

Interest-bearing debt =EUR 2.000.000,-

Cash = EUR 150.000,-

EBITDA multiple = EV/EBITDA = EUR 5.250.000 / EUR 700.000 = 7,5.

Note that the EBITDA multiple does not provide for an information about how much the buyer paid to the seller for the 100% stake in the company. The EBITDA multiple merely represents a standardized comparable to estimate the company profitability with respect to the total amount of capital employed.

However, from the above data, we may try to calculate the the equity value of the company (provided that the company Enterprise value has been calculated based on the above-mentioned simplified formula for enterprise value calculation).

Equity value = EUR 5.250.000 - EUR 2.000.000 + EUR 150.000 = EUR 3.400.000,-

Calculating the EBITDA / Equity value multiple:

Equity value / EBITDA = EUR 3.400.000 / EUR 700.000 = 4,86.

In this very point, there are many mistakes in the use of EBITDA multiple. In practice, the users of this method often use the publicly available figure of 7,5 Enterprise Value/EBITDA multiple, however, apply this figure to the valuation of their equity stake in the company.

By doing this, they overvalue the company equity from EUR 3.400.000,- to EUR 5.250.000,-.

If the transaction value should only comprise of the share price, the misinterpretation of the EBITDA multiple would result into the overvaluation of the company shares, which would be sold at a higher than fair value. Simply put, the shareholder would earn more than the amount, supportable by comparable companies valuation.

However, even a correct use of the Enterprise value does not guarantee a correct calculation and interpretation of the EBITDA multiple. As we will show in the subsequent article, the reported transaction data itself provide a skewed information on the executed M&A transactions, leading to the risk of an inaccurate EBITDA multiple calculation.