It seems like every week, there’s another news headline about a seller landing a deal with a jaw-dropping multiple — usually touted by an investment banker or M&A advisor eager to demonstrate their ability to secure killer valuations on behalf of their client.
You’ve read the claims: ‘We routinely secure a [insert eye-popping number here] multiple for our clients.’ But when you hear about a multiple in any deal, you are likely hearing about a ‘headline multiple.’ In the wealth management industry, these flashy numbers are often more smoke than substance. Do you ever wonder why there is rarely any context offered beyond the multiple? Like, ever?
The old saying, ‘You tell me the price and I’ll tell you the terms’ crosses my mind whenever I see M&A multiples tossed around without context. I often doubt the accuracy of these claims. Many in the industry don’t understand — or don’t want to acknowledge — that the headline multiple is among the most misleading data points in any given deal.
Sell-side advisors are not the only culprit. Buyers also use headline numbers to obfuscate the reality that their offers are below market. In both cases, I don’t think either party is trying to misstate the reality of the situation. Rather, they are drawing attention to a number that is not the most relevant but that makes a seller feel good. For the purposes of this discussion, let’s ignore for now the plethora of critical information beyond simple P&L data that drives an offer and instead examine the factors that determine a headline multiple.
Multiples are generally based on a company’s earnings before interest, taxes, depreciation and amortization, or Ebitda. This is essentially the business’s net income prior to any adjustments to its profit and loss statement (P&L) before anyone (sell-side advisor or buyer) receives it. Businesses are most commonly valued as a multiple of their Ebitda.
Another important metric is adjusted P&L. This is what your P&L becomes after a buyer or selling advisor receives it. Adjustments are made by removing expenses or adding expenses to the baseline number. Sell-side advisors are notorious for trying to remove critical expenses from the P&L in order to artificially inflate Ebitda, while buyers sometimes insert expenses into the P&L to reduce Ebitda. This often sparks a battle between the two parties in a negotiation.
Say you have $1m in baseline Ebitda. The sell-side advisor’s analysis might strip out certain expenses, lower compensation and eliminate staff positions, among other considerations. The reduced costs increase the company’s Ebitda on paper, which results in a higher valuation; if the seller eliminated $200,000 of expenses, the Ebitda given to buyers rises to $1.2m.
Say, then, that a buyer makes an offer to purchase the business at a headline valuation of $12m. Simple math says $12m divided by your baseline Ebitda of $1m is 12x. The sell-side advisor will happily announce that they brought in a 12x offer on a business with $1m in Ebitda. Amazing, right? Now every owner of a similarly sized RIA naturally thinks their firm should trade at 12x Ebitda.
Not so fast.
When deals are evaluated more closely, the actual offers are often broken into two components: an amount for the current business and a separate amount for expected growth post-acquisition — called an ‘earnout.’ The aforementioned offer might break down like this:
- $12m headline offer
- $8m initial consideration (we will ignore term details for now)
- $4m contingent on achieving growth targets over the next 24 months
Quick math reveals more accurate multiples.
The $8m initial valuation divided by the adjusted Ebitda of $1.2m is actually a 6.7x multiple. If you use the baseline Ebitda of $1m, it represents an 8x multiple. Therefore, depending on how you want to evaluate the offer, it’s actually somewhere between 6.7-8x, not 12x. The additional 4x is entirely dependent on the seller achieving an expected growth rate after the deal closes — and I’ve seen some highly aggressive growth projections in these earnouts that look nothing like the seller’s pre-transaction growth rate.
Another consideration is how much time the seller will have to hit those growth rates. This is complicated by the fact that the first year after an acquisition is largely spent tied up with integration between the two parties, as advisors and other staff settle in and learn the new systems and processes. The additional $4m may come, but sellers should be honest with themselves about the growth assumptions they make and the time it will take to actually earn growth-based earnouts.
Another consideration: Sell-side advisors often base their success fees on both the closing economics and the earnout. I never understood the logic in deal advisors receiving compensation on an earnout, since they have no role in delivering value in this area.
And let’s not forget the fine print. These headline multiples often include retention periods that stretch the valuation over several years, or other terms that make the offer less desirable. Founders can easily get caught up in the excitement of a high headline number but fail to grasp the full terms, setting themselves up for disappointment.
It’s crucial to understand post-acquisition economics when comparing offers. An offer that pays 1-2x more upfront but results in significantly less value over time due to inferior growth incentives, diminished quality of life or fewer resources should probably be rejected. Beware, some sell-side advisors might push for the former because it boosts their compensation, even if it’s not in your best interest.
Focusing solely on headline multiples is shortsighted. A comprehensive understanding of deal terms including payment timing, retention periods, earnout conditions and the buyer’s equity requirements is just as critical. And while valuation and terms are important, the most important consideration for sellers is which buyer offers the best cultural fit for you, your team and your clients.
RIA dealmakers should stop defining the best deal as the one with the highest upfront valuation and start defining it as the one with the best blend of cultural fit, initial economics and post-acquisition quality of life.
In the lifespan of a M&A transaction, headline multiples are meaningless. It’s time we stop giving them so much weight.
Allen Darby is the CEO of Alaris Acquisitions, a sell-side M&A advisory firm helping wealth management firms find and match with their ideal buyer.
