Mind Your Business: The Value of EBITA

By Steve Michaels

Q.    I have been under the impression that telemessaging services are always sold by using a multiple of monthly revenue. A buyer from outside the industry has recently approached me to purchase my business, but they want to offer me a multiple of EBITDA for my business. What does this mean, and how do I figure out the EBITDA for my business?

A. Actually, EBITDA is a much better way to value a business. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, and it reflects your profit margin prior to any to any booked expenses. A potential buyer will use this to determine a multiple, which they would use to calculate a return on their investment (ROI). Let’s say you are billing $30k per month with a 25% EBITDA profit margin. That would mean that you are netting $7,500 per month, or $90,000 per year, prior to any interest, taxes, depreciation, and amortization.

The industry as a whole has used the “so many times monthly” formula for a long time. In the past, some smart individual came up with the formula of X times monthly billing, and this formula has stuck. However, when you compare two businesses that are both billing $30k per month, with one showing a profit margin of 20% and the other 30%, should they both sell for the same price?

A telemessaging service with minimal profit and technology can sell for around 2.5 to 2.8 times annual net, whereas a highly profitable operation with the latest in technology, management in place, and located in a major market could sell for as high as four times annual net. If the hypothetical $30k per month business mentioned above is averaging a 25% EBITDA, then it would most likely sell for between 3 to 3.5 times yearly net. For the sake of this particular example, let’s assume that it is 3.2 yearly net, which means the selling price would be $90,000 x 3.2, or $288,000 (which equals 9.6 times monthly billing).

The EBITDA method of calculating the selling price of a business reflects a more accurate timetable in which you would receive a return on your investment. That is, all things being equal, if a buyer pays 3.2 times yearly net, it would take the buyer 3.2 years to get his purchase price returned to him in the form of profit from the business.

Steve Michaels is a business broker with TAS Marketing and can be contacted at 800-369-6126 or tas@tasmarketing.com for questions.

[From Connection Magazine November 2007]