Is the Broker "Negging" Me or Am I too Cheap? TTM vs Average.

August 25, 2021

by a searcher from Texas A&M University in Johnson City, TN, USA

On deal below, I came to an impasse with the Broker/Seller, and was told "You are choosing to include 2017 and 2018 in your average. That is your opinion and methodology, but it is not market or correct to do so. Not even bank underwriters do this. You have the TTM earnings in the financials."

Broker also asked me to exclude 2019 from consideration which was basically a $0 year (I accepted their explanation)- but I wanted assurance through significant seller note that sales would continue is a strong way. The “TTM” also happen to include almost all of 2020 results in addition to abnormally up results in 2021 YTD, which looks a lot like trying to cram 2x years of earning into a single TTM.

Posting full details to help other current searchers and get some honest feedback. The following are the real numbers- am I too cheap?

* EBITDA numbers, I have taken off unreasonable addbacks and budgeted for an owner salary of ~$100k/yr

Asking Price = $3,000,000
Sales = approx. $1M in good years
EBITDA* = $306k (2017), $256k (2018), $21k (2019), $444k (2020), $391k###-###-#### YTD 1st 7mo), TTM claimed at $940k by Broker with their addbacks
Key Detail = Sales are very lumpy, only 15-20x POs per year, loss of one key PO is big impact on earning. Top and bottom line growth in TTM driven by 1-3x key POs. And Seller runs business, no employees to transfer (normal industry, this is not software).
My Offer = $1.25M EV, , 60% cash at close, 20% seller note with 10y term, and a separate 20% forgivable seller note due at end of year 2 tied to performance of first two years only. I offered to meet the Seller request of $2M EV, but only through additional earn out / forgiveable note. Cash at close kept to $750k, which I do not intend to up.
Seller Waiting for = $1.25M cash at close, with seller note to $2M EV. Broker tells me they've had other offers in the same cash at close range as me, which tells me that I'm not the only one valuing it this way.

I am self funded, prefer SBA option. My point of keeping cash at close lower is to keep seller engaged in what is going to be a potentially tricky hand-off at close with a no employee business.

This is not the only deal that I have been low or outbid on. Another deal went to another buyer for $1.65M at 4.1X EBITDA, 10% seller note (SBA), with no setoffs, despite 50% earnings tied to a single owner controlled contract. Another I am currently outbid on, the TTM has forced top offer to $2M at 4-6x historical EBTIDA, 10% seller note (SBA), with no setoffs, where TTM is improved in 2021, so currently at a 4x TTM.

So, am I too Cheap? What will banks underwrite? Any comments/advice welcome!

Reply by an intermediary
from Wake Forest University in Winston-Salem, NC, USA

Valuation is about the future ability to generate cash flow. There are multiple ways to determine the value, some forward-looking, some historical. One forward method is to use a DCF model (but just be aware that forecasts are extremely hard to accurately predict even if you live within the company and DCF is highly influenced by a host of choices/inputs). Another method is looking at historical results with the assumption that they are representative of future results. Thus looking at past years, whether an average or LTM, is not a hard and fast rule, it is more about which period(s), on an adjusted basis, are more likely to represent the future. Which as ^redacted‌ points out, has taken a whole new dynamic as some companies did really well in the last 18 months and others did poorly. Some of that performance is sustainable, good or bad, and some was an anomaly. Now enters the use of multiples from comparables. When using that valuation methodology, if everything was consistent and ceteris paribus, and the LTM was the most reasonable representation of the future, then you should be using LTM as the comps that were in the database had their final year of financials as the denominator (not their last three years as the denominator). If LTM is not the most representative, but 2019 is (for example), then you should use 2019, and if the last three years combined are the best representation, then use an average or weighted average, etc. Then take ^redacted‌' advice and talk to your lender. Some of where the three-year average comes from is lenders will do backtesting on the debt service coverage ratio if they feel like prior years' performance may repeat itself.

Reply by a searcher
from The Juilliard School in Danbury, CT, USA

I think the valuation on this business is a little bit high, but I wouldn't lose a deal over it if you're confident in the business and your abilities to grow it. Have you pre-screened the numbers by lenders from an SBA standpoint yet? I think the 21K net profit in 2019 is going to be a major issue for most unless you're willing to put down considerably more than the standard 10%. Have you asked the seller why the business decreased each year from 2017 and what he did to turn it around? Does the top line revenue reflect that as well? (He's not just cutting expenses, right?) This might be just a personal preference, but I would be very cautious with this deal and would be concerned that it is only turning around due to COVID-19 which is not sustainable long term and I most definitely wouldn't consider an SBA loan with a personal guarantee for something this volatile. That being said, revenue based financing might be a better route for you without the guarantee which would also potentially help you to mitigate some of the risk by offering the additional 10%-15% structured as some sort of seller financing or earn out etc...

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