Set-Aside Alert
By Scott E. Semple, Senior Advisor & Sharon B. Heaton, Founder & CEO, sbLiftOff
For most small business entrepreneurs, your company is your most valuable asset. Understanding its value is important for both growing your business and planning an exit. So how do you establish and maintain an accurate valuation of your company?
A valuation represents your company’s total worth. This is a calculation that considers a company’s assets, earnings, expenses, and debt, as well as market and industry trends.
A business has both tangible and intangible assets. Tangible assets include equipment, inventory, and real estate. For service-oriented businesses, a sizeable component of value lies in intangibles such as brand name, management, talent, intellectual property, and customer databases. And for government contracting firms, there is a ‘third rail’ of valuation, which includes: prime contact vehicles, facility security clearance level, certifications (ISO, CMMI, etc.), and other characteristics that enhance the company’s value in the eyes of an acquirer.
While there are several methods used to establish a company valuation, the most commonly used for GovCon M&A deals are discounted cash flow and comparable company analyses. Discounted cash flow analysis requires detailed multiple-year cash flow projections, so looking at comparable company analyses will be helpful here.
This valuation metric is based on how similar companies have sold within your marketplace and current market conditions. The past 5+ years have seen the GovCon market trading at near record highs; according to GF Data, the average valuation of private M&A transactions for companies with a total enterprise value of $10 million to $25 million in 2021 was 6.2x EBITDA. Looking at how companies have been priced in the past, however, may not be an accurate reflection today as interest rates, inflation and other economic factors have brought new complexities.
So, the two key numbers required to establish a comparable company analysis are: 1) adjusted EBITDA; and 2) the multiple applied to your EBITDA. Here’s a quick guide to developing these numbers:
5 Steps to Establishing an Accurate Comparable Company Analysis for Your Company:
1
Determine your EBITDA
Take net income for the last 12 months or fiscal year, and add interest paid, income taxes paid, depreciation and amortization. EBITDA reveals a company’s earnings power.
2
Adjust your EBITDA
This step adjusts EBITDA to make the company’s cash flow as representative as possible to what the buyer will experience over the long run.
- Increase EBITDA by expenses incurred in the last 12 months that the new owner would not incur, such as personal expenses, new hires, non-business travel, cars, or other professional fees outside the ordinary course of business
- Decrease EBITDA by non-recurring income, such as favorable legal judgment or sale of assets outside the ordinary course of business
- Decrease EBITDA by expenses that the buyer would have to incur that the seller has avoided, such as hiring a CFO or a technology upgrade
3
Understand the Variables
The market will determine a multiple which, when applied to your adjusted EBITDA, will provide a reasonable target price. However, there are several variables that can impact this figure:
- Well-established project management and business development processes
- Strong customer relationships
- High profit margins
- Low customer concentration
- Low supplier concentration
- Experienced management team post-transaction
- Strong recurring revenue
- Outlook on long-term industry growth
- Comparable multiples paid for other companies in your industry
For federal government contracting set-aside firms there are additional factors which may increase or decrease the multiple including:
- Percentage of set-aside revenue (generally a negative) vs full and open revenue (a positive); multiples for companies that have designations with no full and open work can between 3 and 5, with some full and open work 5-7, and with complete full and open work 5-9+
- High-value prime contract vehicles
- Facility security clearance level, certifications, and other GovCon value-add characteristics
- Amount of backlog
4
Determine Your Appropriate Multiple
An M&A advisor can establish a peer group of comparable deals and adjust for intangibles identified in step 3, as no two deals are alike.
5
Calculate your Target Price
This is the result of the adjusted EBITDA from step 2 multiplied by the appropriate multiple from step 4.
An internal valuation is just a starting point. An M&A advisor will work with you to identify potential buyers, structure the best transaction, and bring the sale through completion. They will conduct a financial analysis of your business, find the appropriate comparable companies, and come to the right valuation for your company. An experienced advisor will make sure you don’t overlook any intangible company assets that you may take for granted.