I often get asked “what’s the appropriate EBITDA multiple for (fill in the blank) industry?” I don’t care for the question as whatever average I can pull out of a database is largely meaningless. Other factors impact a company’s value other than the industry in which it operates, but no one seems to be curious about that.
Instead of focusing on multiples, let’s talk about how prices changed between the issuance of a letter of intent at closing. A recent study of deals closed in 2021 by the Alliance of M&A Advisors found that for deals under $20 million in purchase price, 16% of the deals eventually closed above the LOI price with an average premium of 14%. Conversely, 17% of the deals closed below the LOI price with an average downward adjustment of 18%. Looking at deals over $20 million, the percentages above and below are similar, with upward adjustments averaging 6.6% and downward adjustments down 14%. Deals closed in the first half of 2022 have shown higher upward adjustments than 2021—20% on average for those that repriced while the size of the downward adjustments are similar to 2021.
What drives the price up or down? Two of the most common factors are company performance during the diligence process and changes in working capital.
Because of the amount of time that elapses during the sale engagement, the changes in company performance may merit a renegotiation of the purchase price. The average EBITDA growth rate for 2021 deals was 10.4% so it’s not uncommon for the trailing 12-month performance at the time of due diligence to come in higher than the run rate when the company was first being offered for sale. Of course, the opposite holds true if the momentum achieved prior to the decision to sell the business starts to fade during the process, necessitating the downward adjustment.
Working capital can be a bit trickier and is often in dispute. Items found during due diligence such as uncollectable receivables, obsolete inventory and missing reserves or accruals will drive down the price at close. Increases in working capital driven by continued growth of the company will lead to upward adjustments, as can excess inventories that many companies have amassed as a hedge against rising prices or to ensure supplies during the post-pandemic era.
Given that prices can change post LOI and that many factors beyond the specific industry are taken into consideration when developing an offer, you can see that reported EBITDA multiples from any source are the result of, not the driver of pricing decisions.
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