Can two companies in the same industry have drastically different valuations? In short, the answer is a resounding, “yes.” To discover how this is possible, let’s consider the example of two companies that both have an EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of $6 million, but with two very different values. Business One is valued at five times EBITDA, which prices it at $30 million, whereas Business Two is valued at seven times EBITDA, meaning it has a value of $42 million. What things factor into this huge difference?
Difference Factors
To determine a company’s value, several factors must be considered. Check out the checklist below.
Value Difference Checklist
- Revenue Size
- Profitability
- The Market
- Growth Rate
- Regional/Global Distribution
- Management & Employees
- Capital Equipment Requirements
- Systems/Controls
- Uniqueness/Proprietary
- Intangibles (Intellectual property/patents/brand, etc.)
Growth Rate and Value
Several variables on the above checklist stand out, with the top one being growth rate. Growth rate is a major value driver when buyers are considering value. Business Two, for example, with its seven times EBITDA has a growth rate of 50%, whereas Business One, with its five times EBITDA has a growth rate of just 12%.
Discovering the real growth rate story means answering some important questions:
- Are the company’s projections achievable and believable?
- Where is the growth originating? In other words, what services or products are driving growth? Will those services or products continue to drive growth in the future?
- Are there long-term contracts currently in place?
- How is the business obtaining its customers for the projected growth?
- How reliable are the contracts/orders?
Ultimately, finding the difference in value between two businesses, that otherwise appear similar, usually resides in growth rate. This is a factor that should not be overlooked. It is essential to know a company’s growth rate as well as the key questions to ask regarding its growth. If you are going to obtain an accurate valuation as well as understand the valuation between different companies, this part of the process cannot be overlooked.
—
Copyright: Business Brokerage Press, Inc.
Photo credit: alphaspirit via Adobe Stock