One of the questions I get asked a lot—and it's a question that almost always makes me smile—goes something like this: "Hey, what's the going EBITDA multiple for a firm like mine?" I smile because if valuing a firm is that easy, I should be jailed for charging $5,000 for a valuation. (Though a professional used to charge $1,000 to tell you what your firm is worth, and it was always the equivalent of 1x your AGI/Gross Profit. I mean, if you're gonna scam someone, the least you could do is require the use of a calculator by insisting that it's 98% of your AGI.) Anyway, the EBITDA multiple has a long history of being useful in the valuation process. It's constructed the way it is to make comparisons easier, since the two firms you might be looking at could have different capital structures, be housed in differing tax jurisdications, and so on. It's so useful, in fact, that it will likely be foundational to valuation theory for decades to come. What is EBITDA? Earnings Before Interest, Taxes, Depreciation, and Amortization. These four categories are essentially stripped from your overhead structure, effectively increasing your net profit. Think of it as a measure of the risk—and thus the return—on that investment. Skipping any IRR (internal rate of return) calculation, here’s a simple way to look at it:
- A multiple of x4 implies that you’d charge 25% interest on a loan to the enterprise. That’s quite risky, and so you’d pay a low multiple.
- A multiple of x10 implies that you’d charge 10% for that loan, and either the risk is low, or the opportunity is great.