When we say that most small businesses sell for 3-5 times EBITDA is that with or without their working capital? Does the working capital explain much of the range between the 3 and the 5? I’m curious to hear from others because I don’t have enough data points on my own to know this. I only know the deals I’ve worked on.
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1) All databases are different. They include/exclude WC, either fully or partially. (Ron Buck post). Many of these databases started with retail businesses where AR is typically absent, and no AP due to cash accounting.
2) There is no $ threshold for inclusion/exclusion of WC. Appraisers use Shannon Pratt's book (which says >$5 M revenue for WC inclusion) to defend their valuation. I have confronted Shannon while he and I taught BV for 8 hours together. He has zero basis to justify his position. However, for appraisers, judge is their ultimate client not the transaction buyer.
3) WC has multiple definitions. Suffice to say accounting definition of WC has no place in M&A. DFCF (Debt Free Cash Free) is overly simplistic. Cash is often part of WC (think of customer deposit), and A/P and taxes are not.
4) WC components differ for each company. Depends on the business, the business model and their accounting policies.
5) Even if WC components are defined and agreed by the two sides, how does one quantify $ amount of WC to be included in the value, or to be funded by the buyer on top of value?
So, how does a buyer address this chaos?
A) Use multiples as a guide only.
B) Run pro-forma financials making sure i) you can fund the deal value including WC, ii) you can service the debt and iii) ROI is acceptable, Then, make the offer at the deal value used in the pro-forma (including WC), or make the offer after deducting WC from the deal value used in the pro-forma.
Just remember, it is in the best interest of the buyer and the seller to include WC as part of the transaction.