Getting to “Your Number” in a Sale Transaction
Operators and investors in the MedTech space analyze EBITDA as a way to measure operating performance and as a metric to establish value.
EBITDA based on The Kinsella Report survey completed October 2020 indicates an average of 15.7% for reporting companies with a range of 7.2% to 27% and a median of 11%. (The Kinsella Report is an annual survey of Medtech contract manufacturers that collects data to provide benchmarking assistance to industry participants.)
Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a common metric on which company valuations are commonly based and easily calculated based on yearend financial statements.
Adjusted EBITDA is a bit more challenging and often the source of some considerable discussion among buyer and seller.
We did not ask Survey Participants for their calculation of adjusted EBITDA but from our experience the calculation may result in an adjustment of 100% to 200% over calculated EBITDA. What do Sellers and their advisers use to adjust EBITDA and what do Buyers consider deducting from EBITDA?
Sellers’ Adjustments to EBITDA (add-backs) may include the following:
- Owner perks: cars, airplanes, boats, second homes.
- Personal credit card expenses run through the business.
- Excess rent above market on property used by the business but held by the owners outside the business. Assuming Seller will rent to Buyer at market.
- 401k matching contributions (Does Buyer want the first thing they do after closing to announce a cut in the 401K contribution? Not likely.)
- Employee bonuses, see comment above.
- Expenses related to non-recurring events such as payments to consultants for a software implementation; moving expense; fire or weather-related expenses or other natural disaster expenses etc.
- Employee salaries for inactive family members or retired managers or owners.
- Inventory adjustments due to prior write offs (re-valuing inventory previously written off) (Contentious).
- Operating leases, as opposed to finance leases (Contentious).
Buyers’ Adjustments to EBITDA, subtractions from EBITDA:
- Maintenance capital expenditures as opposed to growth capital expenditures.
- Staffing requirements to maintain the business in the absence of the owner operator.
- Inventory valued at lower of cost or market or average cost. No value for finished goods without PO.
- Inventory not judged saleable in the course of the next accounting cycle.
- A/R > 90 days old.
- Potential warranty or litigation claims.
- Non-operating income.
- Foreign exchange gains.
Approach to Adjustments
Some Sellers push aggressively at the outset of an engagement to sell their company to include a wide range of add-backs recognizing that sellers will push back. The argument being that the purpose of due diligence is to arrive at agreement on add-backs. There are a couple of problems with this approach: it creates distrust at the outset as Buyers may quickly recognize that many of the add-backs are unreasonable and this may cause Buyer to have doubts about the Seller’s veracity. This could be an important issue if Seller intends to retain Owner after the sale.
No Seller wants to leave “money on the table” a notion with which we as Seller advisors completely agree. We have found that presenting add-backs which have solid, supportive arguments allow for productive negotiations and lead to closed deals.
Beyond Adjusted EBITDA
While adjusted EBITDA is a metric of considerable import in pricing a deal, most sophisticated Buyers are focused on the prospective value of the business based on projected EBITDA. Buyers acquire for future cash flows. Spending time on thoughtful projections to illustrate the cash-generating upside potential of the business can make the discussion over adjusted EBITDA an easier one to have and can help in supporting a stronger multiple on adjusted EBITDA based on prospects for the future of the business. Buyers want to value on past performance but buy based on future potential.
Kinsella Group, Inc is an investment bank focused exclusively on the medtech and medical contract manufacturing markets. Kinsella Group has been representing buyers and sellers in this space for over 20 years, working to exceed desired outcomes. For more information, please contact Bob Kinsella at firstname.lastname@example.org or by calling (312)229-1357.