4 Reasons Why Valuation Data May Be Rubbish (Especially In The Lower Middle Market)
By Tom Schramski, PhD
Volume 1 Issue 13, July 22, 2014
Recently, we had a chance to review published data on a variety of actual 2014 transaction values for “lower middle market” M+A purchase multiples, including healthcare companies. In plain English, this means the Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) of various companies multiplied by a number to achieve the actual selling price. According to numerous external market sources like Axial, Pitchbook, and GF Data, their average multiple of EBITDA ranged from 6.5x to 11x. That’s quite a range and there is excitement because these are the highest multiples of the past decade.
This issue is a significant one for tens of thousands of healthcare businesses who are planning to sell their businesses in the next five to ten years, especially Baby Boomers. It’s also critical information for financial buyers (like PE firms) and strategic acquirers (like large healthcare segment companies), who are trying to plan and invest for the future. Their shareholders are depending on them and their relative success impacts thousands of other people.
The problem with this recent data, as well as that provided by other M+A and analytics firms, is as follows:
- The “lower middle market” is commonly defined as $10 million to $250 million in annual revenue. This is a huge span of economic activity and there is typically a significant difference in operational capacity and access to capital across this span, depending on the market segment. It’s not an apples-to-apples comparison.
- Even with this definition, the transaction studies cover only a very small percentage of companies. According to the US Census Bureau, there were 27,000,000 businesses in the US in early 2014, with only 300,000 earning over $5 million annual revenue (.11 of 1%) and only 150,000 earning over $10 million annual revenue (.06 of 1%). How representative is this data for all of the other healthcare businesses that are trying to use the data to make informed decisions?
- Because of the small sample sizes (Axial and GF Data cited 30 total transactions to date in 2014) and the likely high variance, how useful is this data to the average lower middle market healthcare business owner?
- The statistics tell us nothing about what factors, apart from EBITDA, come into play: location, relevance to buyer strategy, regulatory environment, timing, and market position.
The fact is that the vast majority of lower middle market (and below) transactions are never recorded in any database. While this is understandable from a privacy perspective, it helps to observe the market values that would be useful to sellers and buyers. One of the larger 2013 healthcare acquisition reports by Irving Levin Associates lists several hundred transactions, but very few yield any relevant information like price/revenue or price/unit. It’s confidential.
There is a lower middle market alternative to the post-hoc approach that relies on the EBITDA multiples of large companies of $250 million or more revenue at transaction. While it is always useful to know about a sales value, it may be more helpful to know what the values are for companies prior to selling and how to maximize value in a way that is attractive to potential buyers. In essence, the past can be instructive, but how do I best build value in my $10 million health organization or my $15 million DME?
We’re going to focus more in this area in the coming months with the goal of creating a more compelling, data-driven view of the healthcare marketplace that will be of strategic value to sellers and buyers alike.