Scale: Episode 5 | Is your EBITDA lying to you? Why buyers are butchering valuations

Dave Heywood (00:00)
Your business might be worth less than you think. So, what do investors really value? This is Scale, an OX7 Partners podcast and I’m Dave Heywood For the last decade or so, a lot of businesses have been able to hide behind some quite scrappy operations as long as the top line was moving and EBITDA looked pretty healthy.

I’m afraid those days are numbered. In investors and private equity firms in particular have now completely wised up to what really drives long term value.

They won’t attach huge values to vanity metrics anymore. And there’s a real desire to get into the guts of the business and understand structural risk.

So what kind of business are you actually building?

Are you building a business that can stand independently of you?

Or are you running a business that is almost completely reliant on your individual effort or that of two or three members to survive? Because if it’s the latter, I’m afraid the market is gonna butcher your price.

So if I asked you what your business is worth today, you’d probably take your EBITDA attach a general six to eight times sector multiplier on that. And feel pretty good. about that.

Right now, due to various conditions, one of them being the cost of capital being higher, Buyers are really looking at quality of acquisition. So they’re no longer just looking at your historical net profits, they’re also really looking at and scrutinizing your operational risk. So if your growth

relies all

yeah heroic but unreplicable efforts of a few key individuals across the business, or even you yourself, your multiple may not be seven times, it might be more like three times.

So let’s get into that little bit more. So if you have a B2B business with standardized approaches, playbooks, data, and tech enabled processes, where essentially the exam test is

Can any competent person come into your business and add value? If you can do that, you get premium pricing, can be discounting any other factors here six to nine times eBITDA. Now let’s take that identical business with the exact same net profit, but let’s keep it dependent on

couple of key individuals or founders, personal relationships to keep that growth going.

That multiple

can come right down from three to five times.

So now if we extend that example

with the business generating, say, two million EBITDA the difference between personal effort and institutionalized processes actually becomes a seven million penalty at close.

And I’m afraid it gets a little bit worse than that. Because what is typically attached then to that is a milestone heavy four year earnout. Which means you end up trapped in the business that you thought had been

So how does this show up to an investor?

So again, if we look at two different businesses here, both same revenue numbers and both the same eBit.

what typically shows up in firms without that institutionalized knowledge and processes

Is an investor may observe a highly charismatic founder, two or three superstar account directors. But it doesn’t take long for due diligence to unearth that there’s no consistent sales process. It’s all very heavily personal relationship based.

There’s no clear institutionalized brand at work here lifting everything everything up. essentially if those three or four individuals left the business, would there be much of a business left?

And what shows up on the opposite side is a strong, credible brand out in the market, but it actually drives inbound inquiries of its own. A really well-defined, understood, and executed sales and account management approach, where someone operating at mid-level can step in, follow that playbook.

utilise centralized CRM data and learnings and close a contract at a predictable conversion

it means for founder and key individuals haven’t had to have their handprints across absolutely everything, and yet growth still happens.

And when we talk about that differential between the valuations and ultimate value of the business, the reason the gap is absolutely widening now is because investors want to purchase a revenue machine, not a fragile collective of individuals that once disbanded, there’s not much of a business left.

So when it comes down to what buyers are actually willing to pay a premium for, it comes down to two main drivers.

A really credible brand.

and a scalable growth platform. Sounds pretty straightforward, right? but let’s first of all be really clear on what a credible brand actually means.

It’s not it’s not a logo or the founder or a few people doing really well on LinkedIn.

what a credible brand means, and it all circles around this concept of mental availability, is that when a buyer enters the market and is a in a position to consider and buy, your name is automatically in that consideration set of perhaps a three to five similar businesses, independent of any salesperson’s relationship.

The business owns the market real estate, not the individual.

And that second driver, that growth platform, is having a really defined sales approach.

how that’s typically put together is a replicable playbook. it’s not a collection of individual styles where you have some superstar salespeople and others are left flandering. It’s a really clear, documented, trained system. Again, going back to that idea.

that a middle level employee can follow the sequence and achieve similar conversion rates.

Having access to centralized data assets, so customer data, relationship data, pipeline history, marketing engagement, events all live inside a centralized CRM system, not in someone’s personal text messages or a spreadsheet squirreled away somewhere. it’s open and able to be interrogated.

By anyone within the business.

And you end up essentially with decoupled origination.

Which means that those inbound opportunities that come via your brand and position and standing within the markets.

alongside any other retention acquisition campaigns you might run. Don’t grind to a halt when your sales rainmaker goes and takes a two, three week holiday

and when an investor sees and can touch and feel that defined approach backed by a strong, credible, rooted brand.

Their risk models pick that up, realizing that actually what they’re looking at and are purchasing is a predictable revenue machine and that’s how you command the top end of the multiply brackets.

So how can you get a good sense of real value of your business?

Well, a really quick easy way that you can do right now is to go and take your pipeline and sales data over the last year or two.

Remove anything that you’ve originated and also take out your one or two top salespeople. How much is actually left there?

If the business was sold and the top tier disappeared tomorrow, could the business genuinely sustain itself and continue growing? That will give you a really clear read on where you are right now.

Hope you found that useful. I’m Dave Heywood, and this is Scale , an OX7 Partners podcast.