Canada: 4 EBITDA Thresholds Of M&A Valuation Multiples

In the world of mid-market mergers and acquisitions, it's generally accepted that larger companies within a given industry usually sell for higher valuation multiples – normally expressed as a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). This is because larger companies have more market presence and tend to attract larger, better financed buyers. Greater liquidity (defined in terms of the number and quality of prospective buyers) generates higher valuation multiples.

While every situation is unique, there tend to be 4 EBITDA thresholds where valuation multiples increase. They are EBITDA levels of $2 million; $5 million; $10 million; and $20 million. Note that where referred to herein, EBITDA refers to "normalized EBITDA", after adjusting for non-recurring items and market rate salaries for shareholders and related parties.

The $2 Million EBITDA Threshold

In many cases, it can be difficult for a business generating less than $2 million EBITDA to attract large corporate buyers. This is because large corporations usually look to acquire companies that will "move the needle" in terms of their overall financial results. This is particularly true for public companies who are under pressure to show continued revenue and profit growth. Further, absent a compelling growth story, most private equity firms are not interested in businesses generating less than $2 million of EBITDA. There is often a concern that small businesses are dependent on the owner, or that the loss of a major customer or key employee could be detrimental.

But once the $2 million EBITDA threshold is surpassed, things start to change. M&A transactions usually are in excess of $10 million, which begins to be meaningful. Smaller private equity firms also start to show an interest for businesses generating more than $2 million EBITDA.

The $5 Million EBITDA Threshold

Once a business surpasses $5 million EBITDA, it's generally viewed as having some degree of critical mass. This opens the door to a larger pool of prospective buyers – both corporate and financial (i.e. private equity). In particular, many private equity firms purposefully target companies generating about $5 million in EBITDA with the intention of helping them to grow to the $10 million EBITDA threshold discussed below.

The $5 million threshold also tends to be a benchmark for attracting foreign corporate buyers. This is because buyers from the U.S., Europe and other parts of the world that do not have an existing presence in Canada will want to make their first investment meaningful in terms of size, in order to justify the costs of completing an M&A transaction.

The $10 Million EBITDA Threshold

Once a business hits $10 million in EBITDA, the floodgate of buyers opens. Such businesses are viewed as having a meaningful market presence and significant infrastructure. Larger corporate buyers begin to take an active interest. In today's environment, many corporate buyers are flush with cash and need to invest that capital in order to satisfy shareholder expectations. A business generating $10 million in EBITDA usually is viewed as being sufficiently large to "move the needle".

Furthermore, a large number of reputable private equity firms have an established threshold of $10 million EBITDA for new platform investments. As of July 2014, there is over $1 trillion of private equity capital that needs to be invested. Therefore, private equity firms will often compete aggressively for quality sizable investment prospects.

The $20 Million EBITDA Threshold

The last threshold in the world of mid-market M&A (loosely defined in Canada as transactions with a value in the range of $5 million to $250 million) is EBITDA of $20 million. In the current economic environment, it is not uncommon to see such sizable companies fetching EBITDA multiples well in excess of 10x. Not only do such companies attract large corporate buyers, but large private equity firms and even pension funds have an interest. There is a shortage of supply of sizable investment targets; yet lots of demand.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.