Collection Agency M&A: Financial Factors that Affect Pricing

The sale of a business is challenging on many levels. Arguably, the most difficult aspect of every transaction is establishing a mutually acceptable valuation. Like beauty, value is truly in the eye of the beholder. For an owner, determining the value of a business he or she started is an emotional process. Ultimately, the seller’s goal is inevitably to maximize the amount of cash the buyer will pay for the business. This blog is part 1 of a collection agency M&A series that explores how certain aspects of your business affect the value it will fetch on the market. Specifically, it will explain what influence your company’s financial performance has on pricing when it comes to collection agency M&A.

Without question, the single most important factor that influences value is the financial performance of your company.  Are revenues growing or declining? Businesses with consistent growth are valued more aggressively than those with flat or declining revenue. If new clients recently came aboard, the company’s financial performance could improve, and value will be affected.

How Adjusted EBITDA Can Add Value

Beyond revenue, solid income streams can also boost the value of your business. The underlying theory is that a company’s “value” is denoted by the current income stream that owners accrue. The income stream is typically identified as EBITDA (earnings before interest, taxes, depreciation, and amortization), or the net cash flow of the business. A buyer will then apply a multiple to the selling business’ adjusted EBITDA.

EBITDA is a straightforward calculation. Adjusting or normalizing EBITDA to reflect the selling business’ true earnings is a challenge and needs to be addressed carefully to account for any excess or non-recurring expenses that will not exist after a sale. In general, these adjustments involve “adding back” expenses that won’t carry forward after your business is sold. Adjustment areas include:

Employees Who Will be Jettisoned Post-Sale

For example, a long-term worker who receives a $50,000 salary plus benefits may not be employed post sale. His or her responsibilities will be absorbed by other personnel within the company at no additional cost to the buyer.

Personal Cost

Expenses such as football tickets or monthly country club membership dues should be added back. These are personal benefits to you, not the business.

Your Involvement in the Business Post-Sale

If you plan to step away, you may be able to add back a portion of your compensation; however, the buyer will scrutinize this adjustment by evaluating your role and responsibilities. Your partner’s compensation may be added back as well, depending on whether they plan to remain active in the business.

Rent Payments

If you own the building that your business occupies, you may be able to add back a rent adjustment. In some instances, an owner underpays rent to themselves as a benefit for owning the building. Expect a negative adjustment to earnings to bring rent up to fair market value.

Additionally, buyers may “take out” certain expenses they may incur while running your business post-sale. For example, your business may not have a CFO. A buyer may see the need to hire one, thereby applying a negative adjustment to account for this additional cost. Buyers will also usually want to evaluate historical EBITDA trends over a few years, as well as your current year’s performance and projected EBITDA performance. Be prepared to produce these calculations early on in discussions with a prospective buyer because he or she will always ask for them. If it takes a while to produce this information, a buyer may get concerned about your financial controls.

If your revenues and profits are on the decline, many buyers will project that decline will continue and significantly decrease the valuation of your business. Fortunately, the opposite is also true, so do whatever you can to have strong revenue growth and profits.

When it comes time to sell, obtaining the highest price for your business should be one of your main objectives. Of course, the sales process is complex even beyond pricing. Fortunately, Kaulkin Ginsberg can help you navigate those choppy waters. We have worked with small, mid-sized, and large privately-owned companies, Fortune 500 corporations, and financial investment firms on their collection agency M&A strategies for thirty years. Whether you’re seeking professional sell-side representation, assistance forming a partnership or joint venture, or a transaction assessment, Kaulkin Ginsberg will guide you through the process.

For more information, or to schedule a confidential discussion of your business goals, contact us today.

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