MERGERS & ACQUISITIONS VALUATIONS

The Rule of Five holds that the Enterprise Value (the cash free, debt-free value of a business) of a Business is approximately five times its earnings before interest, taxes, depreciation and amortization (EBITDA), until demonstrated otherwise. The more informing M&A transactions are those closing at much greater multiples than five times EBITDA. There are several reasons M&A prices may be significantly higher:

• Growth Rates: if the earnings stream is growing at a rate that will make the multiple paid today appear to be a five times multiple within two years of the acquisition.
• Potential Synergies: if the value of expected synergies to the buyer, elimination of duplicate costs, access to new customers and markets, are almost immediate.
• Use of Leverage: if the acquirer is able to generate greater returns with the combination of debt and equity.
• Size: a larger company may possess greater stability and lower risk along with greater synergies and growth rates.
• Sizzle: occasionally discipline and good judgment is overtaken by irrational exuberance to purchase.

With the help of an M&A professional, the Rule of Five provides a useful framework in constructing a rationale for a given purchase price.