Determining an appropriate value for your printing company has never been more challenging than it is in today’s economy. While there are numerous reasons to have a company valuation done, they are essential in two situations: when considering the sale or purchase of a printing company, and for estate and gift tax purposes.
Merger and Acquisition (M&A) Transactions
We are seeing two types of valuation structures today for printing M&A transactions:
1) The Traditional or EBIDTA transaction. In this method the value is based on a multiple of his earnings, specifically EBITDA (Earnings Before Interest, Depreciation Taxes and Amortization)
2) The Asset-Based - Tuck In transaction. The seller is paid for the value of the selected assets purchased plus the portion the seller would receive if selling on a tuck-in basis.
In selling your business, it makes sense to use whichever valuation method yields the highest number. If you have a high EBITDA, then you are going to sell based on EBITDA multiple. If you have low EBITDA and higher asset value, then asset-based plus tuck-in value might make more sense.
The Traditional Transaction
The multiple of EBITDA method is universally used to value both printing companies and companies in other industries. This calculation not only provides a good estimate of cash flow, but also removes any distortions that could be prevalent between two companies. It does this by adding back the following: interest expense, which could vary company by company due to different capital structures; taxes, which can vary by the owners choice of the entities tax structure; and depreciation and amortization, which could be due to different depreciation policies.
Once distortions are accounted for, look for items of income or expense that have occurred in your earnings period, often referred to as normalizing adjustments. For example, when we represent the seller in an M&A transaction, we make normalizing EBITDA adjustments for excessive payroll or a family member on the payroll who isn’t actually working, etc. We also make the EBITDA adjustments to normalize the earnings when perks like cars, boats, and vacations are involved.
The primary earnings period used for the EBITDA calculation is generally based on the financials of the company for the last 12 months. Current information is critical in today’s changing market, and buyers no longer want to rely on “average” figures over a long time period. While a three-year or even longer multiple of EBITDA might be appropriate for an estate or gift tax valuation, the M&A buyer is certainly not going to want to pay off a three-year average, particularly if the financials show a declining trend.
So what exactly does the “MULTIPLE” in a multiple of EBITDA represent? The multiples represent your expected return on investment (ROI)—what we call a capitalization rate (cap rate). It is an inverse of your calculated return. For example:
EBITDA of $1M x EBITDA multiple of 4 = $4M Enterprise Value
If you have a multiple of four, your expected ROI is 25 percent. If you use a multiple of five, your ROI is 20 percent. If your multiple is three, your ROI is 33 percent. If the potential buyer has greater concerns regarding the investment, that perceived higher risk will translate to a lower multiple or higher capitalization rate in their offer to purchase your business. Investors have many places they can put their money. Buying a printing company for a high multiple, say six times EBITDA, may not make any sense because it could take six years to recoup their investment; over that period, a lot could go wrong.
The general multiple range for printing companies is three to five times EBITDA, although we have seen a slight uptick as the economy improves and credit markets loosen up. There are numerous factors impacting where your company falls in this range. Generally speaking, the higher the profits, the higher the multiple the buyer is willing to pay. There are also justifying circumstances that might warrant a much higher multiple. This usually happens if the selling company has a niche that is of interest to the buyer.
For example, we’re representing a buyer who wants to get into a very narrow niche area in a very large way. They are willing to pay a multiple of six—but note that this is the first time we’ve seen that multiple in the printing industry in quite some time. It’s painful to say, but if you have no specialty, lower multiples are typical. With a specialty like digital, larger format etc., a general commercial printer with a really strong EBITDA—say 15 percent—might command a higher multiple because they are differentiated from competitors.
Size is another big determining factor in EBITDA multiples. That client we mentioned earlier that was willing to pay the multiple of six also was trying to buy a company with revenues of $100M. If you have critical mass, then you are going to get a premium multiple, even if you are a general commercial printer. Note, too, that critical mass is different in each segment of our industry. If you are a large-format printer, critical mass might be defined as $10M (or even smaller), because there are few large printers in that segment. If you are a book printer, critical mass is more likely $100M.
Two other differentiators that impact the range of the multiple are technology and the customer list. In evaluating technical status, workflow, digital functionality, and web-to-print capabilities are typical factors of the buyer’s assessment. The more automation they see, the higher the multiple is likely to be.
The seller’s customer list also impacts the EBITDA multiple. If the buyer sees great potential to sell more printed product, services, and more volume to the seller’s customers, then they are willing to pay a higher multiple. Contrarily, if the buyer perceives customer vulnerability, it will negatively affect the multiple. If perceived vulnerability is feared, be prepared to demonstrate that there is little risk.
For example, we sold a wide-format printer that had very little customer diversification: 80 percent of the company’s sales where to one apparel manufacturer. In an average situation, that can hurt a multiple, but we worked with the seller to build a strong case for customer loyalty and mutual respect. Then, we researched the market and found a buyer that wanted to penetrate the account for a long time. While they didn’t pay a premium multiple, they did pay more than any other buyer would have because they wanted that account. As a seller, anticipate difficult questions regarding your accounts, their relationships with you, and the typical buying behaviors of your customers. As a buyer, once you move past the initial phases of the transaction, you will see the biggest risk is, “Will the sales continue if you purchase this printing company?”
In the calculation above, EBITDA times a multiple gets you to “Enterprise Value.” We discussed some of the things that affect the multiple. But one of the things it is important to understand here is that we need to subtract out of that enterprise value the amount of secured bank and financing debt or interest bearing debt to get to what the seller is actually going to receive—and that includes capital leases and lines of credit.
Enterprise Value less secured debt = Amount the seller will receive
Sellers often get to this final step of subtracting the bank debt and then realize they won’t get as much money as anticipated from the sale. Perhaps they recently bought a piece of equipment and didn’t consider the impact of that debt on the final amount they would pocket. We have some companies now that are producing higher incomes than they have for several years, but their bank debt from equipment purchases or other debts will still take several years to pay down. For them to realize a reasonable return, they are going to have to continue to pay down their bank debt before they sell. That reminds me of a book that starts off with the statement “Life is hard.”
The Asset-Based, Tuck-In Valuation
Under-performing companies or companies with low earnings levels should consider the asset-based tuck in transaction because sometimes the sum of the parts is greater than the whole. Basically, you sell off the assets and then sell off the “sales” or customer list. By separating the two, you get a higher value than you would if you tried to sell the company in total to one buyer.
Asset-based valuation begins with a calculation of balance sheet liquidation value. It doesn’t mean you are actually liquidating your company. It means you are just figuring out the market value of your equipment. As we all know, there is excess capacity out there, and used equipment values are considerably lower than they were two years ago, so be realistic. To compute this, sum up the Accounts Receivables and assign a probability or percentage of collectability to each. You would do this with all your assets, including equipment, to realistically figure the total value you would receive on your assets.
Once you compute what you are going to receive for you assets, add to that what you can expect from the sale of your sales/customer list or book of business. Asset-based transactions make attractive tuck-ins, in that buyers are willing to pay good money for your sales because they don’t have to buy your other assets, such as equipment. In most cases, the sale of the seller’s book of business is arranged through a royalty rate (percentage) that is paid on the actual sales that are produced and sold by the buyer to the seller’s customers subsequent to transaction.
The range we are seeing for royalty rate is four percent to seven percent over two to four years. We typically use five percent for three years for calculation purposes. Royalty fees do not tend to exceed seven percent unless there are extenuating circumstances—for example, if you are not paying a sales commission on some of your revenues, the buyer might consider paying a higher royalty rate.
Royalty fees in an asset-based transaction can sometimes be a source of friction. Some buyers want to put a ceiling on the royalty rates, or commissions, paid to the seller. On the other hand, some sellers want a floor as part of the transaction agreement, whereby the seller receives a guaranteed minimum payment, even if the royalty is less. Our recommendation is that parties avoid the ceiling and floor mentality. But measures conflict with the big picture goal of a tuck-in. If the buyer ends up paying more royalty fees than anticipated, it means sales are actually above expectation. The ultimate goal of a tuck in is to achieve higher than projected sales. If royalty commission helps that happen by making customer transitions smoother, it is simply a tool to a successful process.
On the other hand, a seller who wants a floor usually requests it so he/she knows the minimum amount they are going to get in order to liquidate the business. But sales are not hard, fast, and absolute for the buyer to predict. If the buyer thinks he/she is purchasing a company with $3M in sales and only $1M comes in, it doesn’t seem fair for the buyer to pay the floor when he/she is already dealing with an unexpectedly large sales loss. It is a matter of what is fair for all parties.
Tuck-in (asset-based) transactions will continue to be popular because they give the buyer the opportunity to take on only variable expense, with no extra fixed expenses, and move into his/her plant and fill up excess capacity—and almost every printer out there wants to fill excess capacity these days.
Estate Tax Valuations
In today’s depressed market, every company should consider getting an estate tax valuation done right away. We mentioned estate tax earlier as another reason for valuing a company. It is important to note that estate and gift tax planning and M&A valuations are two different valuations. For M&A, you want a high value. For estate/gift valuations you want to justify a lower value to minimize your taxes.
With the lower EBITDA values we’ve seen the last couple of years, many of our clients are finding it advantageous to do estate tax transfers and using lower valuations to reduce any tax effect. It is often said the best time to prepare for the future is now. With today’s depressed EBITDA values, now is the time to look at how much stock you can get out of your estate and consider gifting it.
It is easy to support a very low valuation in today’s market, so this is something all stockholders should currently consider.
Whether you plan to sell or buy your printing company, or just gift your stock to maximize tax benefits, be sure you first know exactly what the printing company is really worth in today’s terms. Work with a qualified professional in the industry who can assist you in identifying applicable adjustments and discounts, as well as help you with the most effective timing to put your plan in action. PN