How to value the businesses with sudden jump in EBITDA?

searcher profile

July 19, 2023

by a searcher from University of Cincinnati - Carl H. Lindner College of Business in Bear, DE, USA

A significant number of listings I am receiving have EBITDA numbers that look similar to the following (with revenue numbers increasing with the same rate):
###-###-#### ,500,000
###-###-#### ,000
###-###-#### ,000
###-###-#### ,000


What is your recommendation on the following regarding such businesses:
1. Would you even consider such businesses or just move on (as per the HBR guide, enduringly profitable businesses generally grow slowly. Also if the###-###-#### years old company had a potential to grow like this, wouldn't it be much bigger company now)?

2. If you consider such businesses, how would you value them? Would you take average EBITDA or Weighted Average or something else?

3. If you consider such businesses, what would your pre-LOI diligence look like? what questions you would ask the seller, what numbers would look from in the CIM, etc.

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commentor profile
Reply by an intermediary
from Arizona State University in Long Beach, CA, USA
It depends on the type of business. Is it recurring revenue, contract based, or one time project based? Was the bump due to one very large customer (concentration issue)? The value of the business is really based on the future earnings going forward. Since we can't predict the future, we use prior years EBITDA as a guideline. The EBITDA figure you use should be one that best represents what you can expect to get after you take over. If the bump in 2022 was mostly from one time jobs that may or may not repeat going forward, you obviously cannot give it much weight. If the Seller feels strongly that it will continue, you may need to tie it to an earn-out. If it is based on sticky business (ex. with contracts in place), then it may be entirely appropriate to value it based on 2022 EBITDA.

How is 2023 coming along so far? What's the backlog for the next few months? You should be able to get a reasonable projection for 2023 to validate whether the increased business is sticking or not. Hopefully, this gives you a idea of how to think through the issues. Using a generic formula like average, weighted average, etc. may not be helpful here, since###-###-#### figures may have no relevance to future earnings, if they have genuinely landed large, sticky, customers to justify the increase t0 $1.5 mil EBITDA.
commentor profile
Reply by a searcher
from Roosevelt University in Boston, MA, USA
Yeah I've seen this as well ^redacted‌

Several things could be happening:
1. Revenue and costs for a project are not being accounted for in the same time frames.
2. Owner knew they were selling the business and did a bunch of things that are not sustainable to get paid. The owner stops taking a salary, lets go of key employees, or just plain starts doing funny accounting stuff (complicated reconciliations)
3. They actually did find a way to become more profitable and increase revenue.
4. Company acquired another company that's much more profitable than they were alone
5. A combination of the first 4

I'd consider the business for sure. Ask for a current org chart (is there a real management layer in all the right places), QofE will be huge. Not really sure you'll get any of this pre-LOI in most cases.
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