Weston Delray’s valuation methodology
How we value a business is as much an art as science
What is fair value for an enterprise comes down to what someone might pay for the company. A strategic buyer may pay more than others and at times a seller will not sell to a strategic buyer.
Many methods are used to determine value when it comes to a transaction may it be; Book Value, Discounted Cash Flow, Multiple of Cash Flow and Multiples of something else—for example, some industries are valued at a multiple of subscribers, a multiple of revenue, etc.
Weston Delray’s Approach to Valuation
Weston Delray values Enterprises based on their ability generate maintainable, operating cash flows. We typically apply a multiple to the annual, maintainable operating cash flow as our starting point in the valuation process. We use verified EBITDA as a starting point of operating cash flow.
How do we get EBITDA
We use verified EBITDA as a starting point of operating cash flow.
As with life, EBITDA is not EBITDA and is subject to some adjustments.
History has taught us that we can expect normal adjustments to EBITDA
Normal EBITDA adjustments
Once sustainable EBITDA is determined, Weston Delray applies a multiple of EBITDA to determine the Enterprise Value. Our historical experience is that smaller middle market companies sell at three to five X. The multiple used will depend upon a number of factors including but not limited to the following:
- Sales growth rate
- Gross Profit Margin
- Annual EBITDA
- EBITDA margin
- Working capital requirements
- customer concentration
How the deal is structured is important and may impact the EBITDA multiple.
Other Seller Information
Not all offers are created equally. All cash vs cash and debt or earnout. What is best for a particular seller or situation changes and can evolve. It is important that the seller understands the offers and what the real cash to the seller might be. Contingency payments and earnouts will usually alter the thought process. We work as best possible with the seller to optimize the situation for all parties involved.
At Weston Delray, we are private equity investors with capital on hand. We are happy to discuss options and explain how price differences really work.
Weston Delray’s valuations are almost always based on an enterprise value. Weston Delray does not use equity value as that can be under or overstated. Weston Delray does not usually purchase stock but pays enterprise value and the seller pays off its liabilities. That is not always the case as each situation is different. The shareholders receive the net cash. Equity value paid by Weston Delray less debt paid = value to shareholders.
Depending on the time period involved the value of an enterprise can move during this period. Many factors can cause this including normal operations. Depending on what has transpired during this period will determine any adjustment that is necessary. During normal periods of operating performance the changes in working capital components is a equitable way of dealing with this issue. A working capital adjustment increases or decreases cash at closing based on the performance of the business between executing a LOI and closing a transaction. The working capital adjustment is a balancing number to treat both sides of the transaction in a fair and equitable basis.
An escrow is a hold back of a certain amount of the cash at closing to cover representations and warranties made in a purchase agreement. The size and term of an escrow will vary depending upon the transaction, but typically are 10% to 15% of the transaction value and are typically in place for 12 to 24 months.
From time to time Weston Delray will use earnouts to bridge a valuation gap between buyers and sellers. When the future performance of the enterprise is in question we have found this as an equitable way to bridge this valley.
From time to time Weston Delray will request a seller to take back a Note (sometimes called Seller Financing or Seller Debt). It is common practice that Seller Notes are often subordinated to other debt issued to a buyer to complete a leveraged buyout. Seller Notes are typically structured as term debt payable over multiple years usually in the five year window.