Getting the ‘Double-Digit Multiple’: What Sellers Need to Know

Double-digit multiples are often the buzz around healthcare conference room floors. “I just heard someone got a 15x for their business!” a business owner will exclaim — a multiple far exceeding the industry norm of 4-8x. Is such an astonishing multiple merely an urban legend or is it possible for a middle-market healthcare business owner to achieve double-digit multiples? 

The answer is … it depends. The deal structure is an important consideration when discussing the plausibility of these thrilling business valuations. The terms a seller is willing to entertain can drive multiples higher, as double-digit multiples are rarely achieved without seller’s notes, equity rollovers, and/or earnouts — terms and concepts sellers should know about when they’re working with an M+A advisor to bring their business to market.

Selling your business can be confusing and complicated. A skilled advisor can help you receive multiple offers to choose from and help make sense of them. When offers are made, they can be as straightforward as a dollar amount you will receive at closing, which is based on your adjusted EBITDA times a multiple, or they can be much more complex, with seller financing, equity rolled, or earnouts. The latter scenario is often when we start to see deals approaching and achieving double-digit multiples.

So, what does a double-digit multiple mean, and how can a seller get one? 

To help gain a better understanding of what’s required for a company to receive a double-digit multiple offer, here is an example: A buyer presents a letter of intent (LOI) to an owner of a company with $2.5 million adjusted EBITDA. The buyer offers $25.5 million, which breaks down to a 10.2 multiple — a double-digit offer! However, to achieve such a multiple, the offer contains $1.5 million seller financing, a $3 million earnout, and $3.5 million in rolled equity. Here is what such an offer looks like in a chart: 

Let’s break down the key terms and components of the offer as identified by the bracketed figures in red.

1. Adjusted EBITDA. Starting with your profit and loss (P&L) statement, an advisor like those with VERTESS will take your net income and then add back interest, taxes, depreciation, and amortization to determine your EBITDA. EBITDA is an approximation of a company’s cash flow from operations. To more accurately reflect a company’s true operating cash flow available to a buyer, we adjust EBITDA for any expenses and revenue deemed discretionary, non-recurring, and/or non-operating to calculate adjusted EBITDA. 

On the revenue side, we are now at a point in time when we are typically removing COVID-19 relief loans/grants, stimulus payments, investment income, or one-time gains. On the expense side, we might be removing an owner’s inflated salary, travel expenses, or car reimbursement as well as the specific COVID-19 expenses tied to the revenues received. Adjustments made depend greatly on each owner and how their business was run. Adjusted EBITDA is a pivotal number on which many deal points originate from.

As stated earlier, the company in our example has an adjusted EBITDA of $2.5 million 

2. EBIDTA multiple. This is a number that is multiplied by the adjusted EBITDA to determine a purchase price. As noted, most multiples in a healthcare M+A transaction will be between the 4-8x range, but this is a very general range with many outliers. The multiple will be determined not only by the company’s industry, but its location, solidity of operations, payor mix, services/products offered, revenue, profit margin, and growth potential. In our example, the offer is 10.2x of the $2.5 million EBITDA. This value is usually calculated before any interest earned on the seller note, which equals a $25.5 million offer. 

Now let’s break down the elements of the offer that took us to that 10.2x multiple.

3. Cash at close. This concept is exactly what it sounds like: the amount of cash transferred to the seller at the time of closing. A seller will need to keep in mind that from this cash received, there is often a holdback for 12-24 months, and they’ll need to pay expenses like taxes, lawyer fees, and M+A advisor fees. Notice that cash at closing is only a 7.00x multiple of EBITDA, which might be the current industry average, but the offer doesn’t stop there. The buyer uses other mechanisms such as earnouts, interest, and rolled equity to drive up the multiple, as represented in the chart. 

4. Seller financing. Some sellers are willing to “loan” money to the buyer by holding a note, usually paid at the end of the earnout period. This is known as the seller note and is often a great way for a seller to profit from this transaction if the seller feels confident with the buyer. It’s important to understand that the seller note is most often secondary (subordinate) to any loan the buyer takes out from a bank. Sellers can earn interest over the time they are holding the note, which can add to the cash flow received by the seller. 

The offer provided in our example has a seller that has financed $1.5 million of the total purchase price, which adds .60x to the total multiple. Now we’re up to a 7.60x multiple.

5. Earnout. This is an incentive payment for future performance of the organization. The buyer will set goals they hope to achieve with the seller’s help following close. Buyers use this to further assist with the transition of leadership, with the hopes of incentivizing a seller to help maintain stability of the organization during the transition. The ultimate goal of an earnout is to base it on stability or growth of revenue as a measurement. Buyers prefer to base the earnout target on net profit because of the need for additional spending to support growth. Sellers want to move that target as high up on the P&L as possible since once they are no longer the owner, they have less control over expenses moving forward. 

It’s important to set clear guidelines for the earnout and how the goal will be accomplished. We often see deals with cash at close and an earnout (again, to help incentivize future success after the transition). The deal in our example has a $3 million earnout, which alone adds a 1.20x multiplier to the deal, bringing the multiple up to 8.80x. If the offer was simply $17.5 million cash at close with a $3.5 million earnout, it would then become an 8.2x (7.00x + 1.20x). 

6. Equity rollover. This is the cash amount a seller will invest in the new company after close since the company will now be owned by someone else. In the example provided, the buyer is offering $25.5 million as the enterprise value of the transaction and the seller is giving the buyer back $3.5 million to invest in the “new” company. 

This rolled equity means the seller is now a part owner of the new organization. When they sell it in future years, the seller will again have an opportunity to make a gain on the investment. This “second bite of the apple” often yields even higher returns because of the company’s increased size. 

For example, assume the seller’s equity rollover of $3.5 million translated to 10% of the new company. A subsequent sale for a purchase price of $60 million would mean an additional $2.5 million in the seller’s pocket, above and beyond the initial rollover of $3.5 million, upon the future close date. 

How much equity the seller will be allowed to hold in the new company depends on the buyer’s specific capital structure and strategy. For buyers to pay a premium price, they want the assurance that the seller has some “skin in the game” and is committed to the business’s continued success. In short, shared risk drives higher valuation multiples.

In our example, this investment carries with it a 1.40x multiple and gets us to the 10.2x multiple. But the multiple can get even higher because…

7. Seller notes are interest bearing. This is an important negotiation point since a seller can determine the interest rate they feel is appropriate. In the example provided, by holding a $1.5 million note and receiving 9% interest for three years, an additional $405,000 will be paid to the seller. This amount accounts for an additional 0.16x added to the multiple total and is usually not considered in the original calculation of the enterprise value, which is why it is calculated last. Payment of the note and interest is not contingent on any performance, unlike an earnout. 

8. Total. Thanks to the seller financing and seller note interest, earnout, and equity rollover, the seller receives a 10.36x multiple and a sale of their business for nearly $26 million. 

All Multiples Are Not Created Equal

As you can see from the example, there are many ways you could calculate the multiple, such as before or after the earnout and after the interest on the note is paid. One key element not included in this analysis is revenue size. If this company is a $5 million company, then the adjusted EBITDA margin of $2.5 million reflects 50% of revenue. 

Higher-than-industry-average margins may cause buyers in the healthcare service delivery space to question whether the bottom line is sustainable. We often see offers of a 5-6x multiple in such scenarios, whereas if the adjusted EBITDA was in the 20-30% range, a seller is more likely to get an offer closer to or possibly into those double digits. 

What This Means To You and Your Company

When you decide to take your company to market, it’s important to understand your financials and have a realistic valuation in mind. It’s easy to assume that because a competitor received a 13x multiple on their business that you will as well. However, as we discussed, there are many factors, both internally and externally, that determine valuation, as does the manner in which it is calculated. Offers with outlier multiples typically include many of the deal elements highlighted in this article and require shared trust and risk between the buyer and the seller.

If you want to gain a better understanding of the value of your company and whether a double-digit multiple could be in your future, please reach out to a member of the VERTESS team.

by Rachel Boynton, MBA, CM&AA and Kim Harrison, MA, CM&AA, CPA