M&A Terminology and definitions – Business Value
We are often faced with terminology that is unclear or misleading or used in a way that is different from its formal definition. This lack of clarity can have devastating impact on business owners who may have a significant misunderstanding about the worth of their business.
So in this article we would like to concentrate on one very important term: What do we mean by “business value” when we are talking about a recruitment agency.
Here’s our definition:
Business Value is a multiple of normalised profit before interest and tax excluding working capital.
But read further, there is some devil in the detail.
Firstly, this only applies to small to medium-sized sustainable companies, say those up to 50 consultants in size. Larger companies, and those that are publicly listed, have value determined in other ways. Very small companies, say those less than four or five consultants, are also valued differently.
Secondly it is important to note that we are discussing Earnings Before Interest and Tax (EBIT) in the above definition. For smaller companies we do not use EBITDA as a measure, but are likely to use EBITDA when discussing larger companies.
EBIT is all profits before taking into account interest payments and income taxes. An important factor contributing to the widespread use of EBIT is the way in which it nulls the effects of the different capital structures and tax rates used by different companies. investopedia.com
EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyse and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. investopedia.com
Thirdly, we have excluded working capital. Smaller recruitment companies manage their finances in very different ways. For example a dominant perm recruitment business may be cash rich where a dominant temp and contract business has a business that requires cash to operate. The “cash poor” business may choose to fund the working capital itself or may wish to arrange debtor financing of some form to manage this cash situation.
To clearly understand the value of a small to medium business we exclude the working capital, even though working capital will be a major item of discussion if arranging a sale transaction.
And finally, we have used the term normalised profit as often small to medium businesses will run their business to minimise tax obligations or to support other business ventures – if that is the case then there is some work to do before true business profit is reflected in the profit and loss statement.
The implications of working capital and normalised profit on M&A transactions will be the subject of later articles.
Hopefully this article gives some information that will allow you to read M&A transaction press releases with some forewarning, and will allow you to ask additional clarifying questions if approached for the sale of your business.
2 M&A Terminology and Definitions | 2.1 What do We Mean by “Business Value”?
This article became part of the popular eBook “Business Valuations in the Recruitment Industry – A Guide for Recruitment Agency Owners” available for download on www.hhmc.com.au
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