Sounds like a straight-forward question, but it’s not. There are multiple metrics that can be used to determine a firm’s value.
What’s the firm worth? I hear that question more than any other, from buyers asking about a firm they want to purchase, and from sellers weighing an offer. There are several ways to respond to this question, but as an analytical thinker, part of me hates every answer. The truth sounds like a cop out: You’re worth what the market believes you are worth. I know, I hate that answer, too.
However, there are some metrics that can give us a good sense of where the market is in regards to valuation. I have several caveats to each metric (naturally), and I firmly believe that you cannot make strategic decisions in a vacuum behind a set of figures. We can approach value a few ways. We can look to objective metrics and multiples from a firm’s income statement or balance sheet.
My personal preference is a firm’s value as a percentage of net service revenue (defined as gross revenue less reimbursables and subconsultants). According to our 2016 Merger & Acquisition Survey of AEP & Environmental Consulting Firms, the median price paid as a percentage of net service revenue was 73 percent. This year, firms believed that if they were to sell their company, they would receive a median purchase price of 75 percent of NSR. If we are using revenue as a metric, we need to make sure that in the future the buyer isn’t going to isolate the selling firm’s clients, and we need to make sure that the selling firm’s top rainmakers are retained after closing.
Many firms want to discuss profit, or EBITDA, as their starting point metric. My contention with starting with a multiple of EBIT, or EBITDA, is that many firms have negative profit, which would make their value ... negative? Plus, using a multiple of profit overlooks one of the major opportunities that exists in M&A – a buyer managing the firm more efficiently than the previous owner using the same revenue stream, at least initially. Profit is not a worthless metric, to be sure, but it does begin a discussion early on about add-back items (items that would be ongoing versus those that would end when the deal closes).
Other metrics that are frequently utilized in M&A negotiations include a multiple of adjusted book value (or a multiple of adjusted owner’s equity, to state it another way), a weighted average approach to either revenue or profitability to smooth out spikes over several years, or a price paid per employee.
Smart firms in M&A use more than one “rule of thumb” metric to guide the discussions and to help propose an initial value, but they always keep in mind that there is a strategic value to any firm that is beyond the spreadsheet. Additionally, they are always ready to incorporate new information or new adjustments into the figures. Things will not be as at and straightforward as they appear on the financial statements for any firm once you progress into due diligence and learn more about the firm’s operations.
One of Zweig Group’s consulting services is firm valuations. For more information, visit http://zweiggroup.com/consulting/valuation/ .
Jamie Claire Kiser is Zweig Group’s director of consulting. Contact her at jkiser@zweiggroup.com.