Typical value calculations – EBIT… what?
The most frequent starting point for putting a value on a company is to multiply the annual profits (known as ‘ EBITDA ’) by a fixed multiple in order to reach a price, often referred to as ‘enterprise value’.
‘EBITDA’ is an acronym that stands for ‘ earnings before interest, tax, depreciation and amortisation’ .
While it sounds (and can be) confusing, EBITDA is a way for investors to determine a ‘sustainable’ profit figure for price calculations, taking a variety of temporary or situation-specific factors out of the equation to leave a realistic estimate of the company’s core financial performance.
Using this approach helps a new potential buyer understand how much profit the business can be expected to generate once they take over (assuming no significant changes), and therefore how long it would take them to see a return on the investment they make by buying the business.
While there are plenty of standard methods for calculating EBITDA, there is no one fixed approach.
Typically, buyer and seller will agree on a basis for calculation before getting too far down the road in discussions, ensuring there is basic alignment from the outset regarding the methodology used to gauge business profitability.
With an EBITDA calculation agreed, attention turns to how much a buyer is willing to pay.
Using a multiple of EBITDA to determine price has some simple logic – the higher the multiple, the longer the investment made by the buyer is at risk.
Commanding a high multiple when selling an agency typically means that there is strong demand for the business, and consequently buyers are prepared to take an increased risk to close the deal.
There are lots of ‘value drivers’ that can boost how much an agency is worth, which include things like:
- Profitability – it’s not only the amount of profit which is important, but also what that profit represents as a percentage of overall turnover
- Niche focus – having a strong level of expertise and accompanying brand in a specialist sector can add significant value in the eyes of a buyer
- Contractor base – recurring revenues from ongoing contract placements help mitigate cashflow risk and substantiate sales forecasts
- Locations – hubs in key cities and talent pools can play a role, both in terms of supporting customers and the agency’s own ability to grow
- Diversified sales & management – one of the biggest risks to the buyer is how an agency will perform without the founder involved day to day, or how losing one or two ‘big billers’ would affect sales – responsibility and revenue generation evenly spread across a wider personnel group can be attractive to investors
- Personnel – the quality, tenure, training, expertise and long-term commitment of key staff members all go towards the value of any business
- Technology & processes – infrastructure and workflows which give the agency a competitive edge or ensure a smooth transition to new ownership can win out over unstructured internal processes
- Client concentration – buyers will be interested in understanding size and diversity of customer base, strength of relationship with key clients as well as ensuring that the agency isn’t overly-dependent on a few vital clients
- Customer contracts – MSA, RPO, exclusive, retained or otherwise, contracts which increase buyer confidence in future profit generation weigh in the scales
- Certifications or compliance – any legal certification or accreditation which provides access to specialist markets can be viewed as a valuable addition
When it comes to determining ‘enterprise value’ (or EV) – the price of an agency – everything hinges on who is looking to buy the company and why .
Ultimately, a buyer is rarely buying a stand-alone business – they’re investing in what that business will produce once they have taken ownership and control.
This can mean many different things for different people.
A large IT recruitment agency in London may not see much value in buying a smaller competitor in Brighton, whilst a manufacturing recruitment agency in Leeds keen to break into the IT market may see it as the ideal opportunity.
In M&A circles, this ‘fit’ between buyer and seller is often called synergy , and refers to the way two businesses can come together to produce something new – and hopefully more valuable.
There are hundreds of examples of potential synergies, from geography (an overseas buyer entering a new country market) to client alignment (a buyer and seller with complimentary customer lists combining to increase market share).
Price isn’t everything (well… not quite)
Naturally, the price offered for any agency for sale is the primary factor to be assessed by the founder(s) and shareholder(s).
But along with price, the structure of any potential offer to buy the company is also important.
Business acquisitions can take many forms and are seldom a case of simply ‘paying the asking price’.
Instead, buyers will offer varying amounts of cash ‘up front’ – sometimes 100%, if they’re extremely keen, but more often making segments of the purchase price dependent on future performance once the business changes hands.
Buyers may also have requirements that key personnel (including owners) remain with the business for a fixed ‘handover’ period, ensuring that the integration of the acquisition goes smoothly.
So, for business owners comparing competing offers, it often comes down to balancing the highest overall price with the securest deal structure – the sale option that delivers the biggest return as safely as possible without pinning too much on uncertainties or locking the founder in to ongoing commitments.
Download: Quick-start guide to recruitment startup funding
Thinking about starting your own recruitment business, but not sure where to start with funding?
Our guide walks you through your options, helping you prepare for what to expect when choosing between investment models.
Inside the guide:
- How to maximise your equity at launch
- Choosing your investment partner
- Options to launch
- Portfolio structures and joint ventures
- Angel investors
- Support from friends & family
- Personal loans
- Government start-up support
- Things to consider
- Case study: Sourcing investment through the RecruitHub network