The short answer is both the past and the future contribute materially to a valuation.
The two components that usually come together to form a valuation are an assessment of EBITDA, both historically and then looking forwards, and then a multiple that is applied to that EBITDA.
The simple way we tell our clients to think about it is that the multiple is guided by the future growth plans and the EBITDA is predominantly evidence of the past. A lot of the valuation, therefore, is forward-looking, but you really need a mixture of both past and future to structure a credible valuation.
Overall, the valuation is based on both historical performance and forecast projections, but there is nuance.
Looking forward – Multiple
The multiple applied during a valuation is more of an indication of how much the business is expected to grow in the future, considering a wide variety of factors (of which forward looking earnings is one). Demonstrating an exciting future growth plan will indicate a higher return on investment and therefore attract a higher multiple. However, it is important that forecast growth is also evidenced by historical performance otherwise it will not be credible.
An important caveat here is that what constitutes an exciting future growth plan will very much depend on the investor profile. For example, strategic buyers will likely be most focused on product fit and how well a particular business can fit into their existing structures, including the revenue and cost synergies that they will be able to deliver. On the other hand, Private Equity (PE) investors will be more likely focused on EBITDA growth and cash generation, and particularly looking for a growth plan where EBITDA at least doubles to generate the appropriate returns.
A word on debt
Lenders have a more risk-averse approach and are therefore much more focused on historical performance than buyers who will be more forward-looking. This is important as an appropriate amount of debt is typically required to support PE structures (particularly if it is a majority acquisition) to ensure they can achieve the required returns.
Overall, the valuation is based on both historical performance and forecast projections, but there is nuance – there will be slightly more focus from PE buyers on the forecast, strategic buyers will tend to look at product fit and synergies, while lenders are much more likely to focus on the historical finances.
EBITDA delivers the credible foundation for the valuation
EBITDA analysis starts by looking backwards. At least the last twelve months will be reviewed to understand the robustness of past earnings, which will then be used as the basis of the structuring EBITDA for valuation purposes. In some instances, if the business is delivering a high level of growth or earnings include a large proportion of repeat or contracted revenue (ideally evidenced in past performance), then it is reasonable to structure valuation off a forward-looking EBITDA.
As Corporate Finance (CF) advisors, we will advise you on this and also look at preparing a ‘Run-rate EBITDA’ which will ensure appropriate value is captured in the structuring EBITDA. A Run-rate EBITDA ensures a full 12 months of value is captured for any new initiatives or recent upticks in performance. For example, if a restaurant opens a new site, but is only open for 6 months of the 12 month period that the structuring EBITDA relates to, the earnings from this site will be grossed up to reflect the full 12-month period.
To structure a credible EBITDA, historical growth and KPIs are the important supporting elements. They provide your CF adviser with an indication of growth over time, growth objectives, and a look into how different strategic decisions were historically made.
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How to get a higher valuation
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