Private businesses are being sold at higher earnings multiples in the current market compared with recent years, according to West Perth firm Mergers & Acquisitions Pty Ltd.
Private businesses are being sold at higher earnings multiples in the current market compared with recent years, according to West Perth firm Mergers & Acquisitions Pty Ltd.
M&A director Jeff Roberts said private businesses traditionally sold at a multiple of three to four times their earnings before interest and tax (EBIT).
“Now you are seeing three to five times and exceptional businesses can be sold at six to six-and-a-half,” Mr Roberts said.
M&A managing director Ross Goldstein said public companies, private equity firms and international companies were all competing to buy local businesses.
“In the 20 years we have had Mergers & Acquisitions, the last couple of years have been the best ever,” he said.
Mr Goldstein said public companies recognised that they needed to work harder to compete against private equity firms.
“That has helped certain businesses, if they are on the radar, to achieve very good prices, but it doesn’t go across the board,” Mr Goldstein told WA Business News.
RCR Tomlinson chief executive John Noordhoek, whose company has made 11 acquisitions in the past two years, agrees that valuations have risen.
“What some vendors are seeking is based on unrealistic valuations,” Mr Noordhoek said.
While EBIT multiples are the main yardstick for valuing acquisitions, it is simplistic to look only at that measure.
For instance, VDM Group is paying 3.82 times EBIT for Como Engineers and four times EBIT for Wylie & Skene.
However, the Como purchase price is based in its historic earnings, for the two years to June 2007, and VDM may have to make extra payments depending on Como’s profits over the next three years.
In contrast, the Wylie purchase price is based on its future earnings, for the year to June 2008, and the vendors will have to pay back some of the proceeds if their business does not reach the projected earnings.
Most of the business sales concluded recently in WA include an earn-out clause, which involves extra payments to the vendors if they achieve defined growth in profits.
Earn-out clauses can be particularly useful when a business has achieved rapid growth – the vendors usually believe they can sustain the higher profits while the buyer is wary about the sustainability of future earnings.
In most cases, the earn-out is about 10 per cent of the total consideration.
An exception was RCR Tomlinson’s agreement to buy Applied Laser Group. The final price could be as little as $12.2 million and as high as $21 million, depending on Applied’s future profit.
KPMG partner Angel Barrio said earn-out clauses helped buyers manage the risk inherent in buying another business, though he cautioned vendors about attaching too much weight to future payments.
“That future payment needs to be discounted,” he said.
Mr Barrio said vendors effectively gave up their share of future profits because they had sold their business, yet in most cases they remained working in the business.
The vendors of most businesses sign two- to three-year employment contracts as part of their sale deal.
In many cases, they also receive a large part of their payment in the form of shares, ensuring their financial interests are closely aligned with those of the acquirer.
Paladio’s agreement to buy Decmil Australia was carefully structured to achieve this goal.
Decmil’s vendors, led by company founder Denis Criddle, will receive 40 per cent of their payment in Paladio shares, making them substantial shareholders in the expanded group.
Ten per cent of the consideration will be held in a special account and released over the next two years subject to retention of several key executives and the achievement of certain performance milestones.
In addition, the vendors will earn extra payments of up to $4 million only if Decmil reaches certain financial targets in 2007-08.
Decmil’s management has been granted Paladio share options that will vest over the next three years.
Last but not least, Decmil’s founder and major shareholder, Denis Criddle will be invited to join Paladio’s board of directors.
