Two very different “7 times annual EBITDA” company valuation multiple scenarios

Once many IT industry company valuations have past their peak it is difficult for many business owners to extract more value from their company than the declining industry valuation multiple is taking away … so if you are going to sell your startup, it is better to be too early than too late.

Over the last years, I have worked in many recurring revenue business model IT industries … and close to the same thing happens over and over. The specific industry valuations rise, peak, then start to decline. This is no different than many other industries, however the evolution typically occurs much faster in IT industries.

No one needs to read an article to learn that the best time to sell their company is at the peak valuation.

Yes, no one needs to read an article to learn that the best time to sell their company is at the peak valuation, however it is well worth understanding the increased cost of being late even if the same “7 times annual EBITDA” company valuation multiple can be received. This market timing is very different than the scenario of selling a common stock for the same price either before or after the valuation peak. For example selling a stock at 60 before it peaks at 75, or selling it after the peak when it declines to 60. There is not a penalty for selling after the peak ... the seller receives the same 60 all cash at closing.

A few comments on “selling at the peak”

Most people can’t pick the exact peak of any market … at least not on a regular basis, especially the valuation peak of an Internet industry with so much bias noise coming from all of the information sources either trying to boost the value or bring it down. And sellers shouldn’t feel inept if they don’t pick the exact peak because even the best traders admit they can’t pick the top or bottom of specific markets or individual stocks on a regular basis. We have all heard the expression “if you can pick 60% of an upward or downward move you have done well”. The truth is picking a 60% move is more impressive than it appears because the trader first has to pick the right direction, up or down.

So back to the business owner in the IT space.

If a business owner sells before the peak of the industry valuation, maybe at 7 times annual EBITDA, he might miss the valuation run up from 7 times to 15 times but he will almost always be in better financial shape than the business owner who sold at 7 times after valuation multiples decreased from 15 times back to 7 times … for the following reasons.

1. One of the reasons industry valuation multiples decline is because revenue growth prospects decline. When and after this occurs EBITDA margins typically decrease as both acquisition cost per customer rises and average revenue per customer declines as more and more businesses compete on price alone. So if the same “7 times annual EBITDA” valuation multiple is being applied to the new lower EBITDA figure, the total proceeds of the sale will be less.

2. There are fewer buyers when industry valuation multiples start to decline, so this typically equates to less attractive deal structures buyers are willing to offer. For example, as an industry is rising buyers might have to pay 75-95% in cash at closing yet as industry revenue becomes flat deal structures become less attractive for sellers, maybe 50-75% down … and of course when industry revenue declines the deal structures become even worse for sellers, maybe 25% down and payments over time (sometimes post closing payments are based on future customer retention). So the post peak “7 times EBITDA valuation” can involve a lower total sales price, and the net proceeds being spread out over many months, if not a couple of years.
   

If an owner realizes he missed the peak industry valuation, the best thing to do might just be to ‘eat-it’ and sell the company (if pivoting the company is not possible or desired), because odds are valuations will not get better. What I have seen many owners do is agree to sell their company today only if a buyer is willing to give them last years higher valuation multiple … which they will not get, so they keep the company. The following year they really want to sell, yet they again want the prior year valuation multiple … which they will not get, so they keep the company. This is a common story.