The Economic Profit Valuation Model
Smaller middle market manufacturing companies ($10 Million to $100 Million in revenues) are often difficult to value, at least to the satisfaction of the seller. Very often, a “follow the leader” valuation approach is utilized in which prior “public” transactions tend to influence new deals. These “measuring sticks” are often heavily discounted to reflect smaller market shares and limited capital of the company being valued. Just as frequently, static book value models coupled with discounted valuations of future anticipated cash flows are offered as “market value.”
Every owner wants a premium for his or her business, but the purchase prices paid for private companies usually do not mimic publicly traded firms. The problem arises when the sellers perceive a very high return on their internal investment (ROI), because they focus only on their net equity invested in the firm. When this unusually high ROI is compared to earnings that can be expected on the after-tax proceeds of an offer for the business, it looks anemic in comparison.
While public companies usually sell for high multiples of net income, the universal measurement for closely held companies is earnings before interest and taxes (EBIT). There can be a significant difference between the two. Public companies often sell for more than private companies for many reasons, including the availability of a ready market and of ready financing.
Smaller manufacturing companies are currently selling for between five and seven times EBIT. Higher multiples of EBIT are possible for unusually well run and well-positioned companies. EBIT can be expanded to include depreciation and amortization (EBITDA). EBIT can be adjusted (Adjusted EBIT) to include unusual ownership perks, benefits, and expenses that a strategic buyer may be confident will not be repeated post-investment.
The issue then becomes “How does a business owner generate a higher purchase price for his or her company?” DSI believes the answer is to be found in calculating the Economic Profit generated by the company now and potentially in the future.
Balance of DSI Global M&A White Paper – Economic Profit Valuation Model