Valuing an enterprise can be a challenging endeavor as not all valuation methods are created equal. In practice, some methods—even the more common ones—do not result in intrinsic enterprise value. Whether you are exploring a strategic transaction, planning for the growth of your company, or simply engaging in strategic planning, consider the valuation basis, its accuracy, and its application to ensure you obtain a value-added appraisal.
Executives dedicated to maximizing shareholder value gravitate toward discounted-cash-flow (DCF) analyses as the most accurate and flexible method for valuing projects, divisions, and companies. Any analysis, however, is only as accurate as the forecasts it relies on. Errors in estimating the key components of corporate value. Components such as a company’s return on invested capital (ROIC), its growth rate, and its weighted average cost of capital can lead to mistakes in valuation and, ultimately, to strategic errors.
Somehow, the EBITDA multiple has become a de facto standard for many small and mid-size entity assessors. Perhaps due to its relative ease in understanding and its application. However, this should not be taken to assume the accuracy of its valuation and/or the comparability of value between companies; an inherent assumption when relying largely on an EBITDA multiple.
EBITDA as a measure of performance and, by extension enterprise value, is popular because it supposedly overcomes the problem of accounting differences. This is partly true, in that the measure is unaffected by differences in depreciation methods, goodwill accounting and deferred tax. Although there is other accounting concerns (revenue and cost recognition issues, pensions accounting, etc.) that do affect EBITDA, theoretically, the EBITDA calculation provides a useful and comparable measure. A crucial failing of EBITDA, however, is that it ignores the very real costs of capital expenditure and taxation that should (and do) affect value.
Let us assume that even if the aforementioned could be satisfied—the major issue with this simplistic method of valuation is that it assumes the entities are comparable. Multiples are an average of the entities of similar size in that industry. Assuming that your entity has the identical make-up of products, future opportunities, financial support, management expertise, and customer base as the average, the valuation results would simply summarize that the average entity in that specific industry historically had a valuation of said amount.
The EBITDA valuation result may be a valid benchmark or reasonableness test for a more comprehensive valuation. However, one its own, EBITDA multiples provide minimum substantive value. Is this entity you are attempting to value “average” in all regards?
Learn more about how to properly value your company by contacting the experienced, professional team at Lakelet Capital.
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