Understanding Multiples in Ecommerce Acquisitions
When it comes to discussing ecommerce acquisitions, the term “multiple” is frequently used, but it can often be confusing. Calculating multiples can be challenging due to the various methods available, and the outcomes can differ significantly. Brokers or buyers sometimes manipulate calculations to present a multiple that appears higher than it truly is. In this article, we will delve into the complexities involved in calculating multiples.
How to Calculate a Multiple
The basic concept of calculating a multiple involves dividing the purchase price of a deal by the profit. At first glance, this seems straightforward. For example, if the purchase price is $10 million and the net profit is $2 million, the multiple for the deal would be 5X. However, in practice the calculation is more complicated because both the purchase price and the profit offer various calculation approaches. Let’s examine each factor individually.
Purchase Price
Continuing with our example of a $10 million purchase price, the first question is – is the $10 million purchase price all paid in cash at closing? Likely not. Usually some portion would be paid at closing, some after a specified time period, and some may be contingent on performance and not paid at all. So, the next question is – should we include all of that in the purchase price when calculating a multiple?
First of all, the contingent payments may not happen at all. Should the inventory be factored into the price? What about ongoing consulting agreements with the seller that involve a salary? These elements can complicate the calculation of the purchase price and significantly impact the resulting multiple. For instance, if we consider a net profit of $2 million and a purchase price of $10 million, but there is an additional $2 million in inventory, including that in the purchase price would raise it to $12 million, thereby increasing the multiple from five to six. Furthermore, how should we account for an earn-out that may or may not be paid? Should it be discounted entirely or partially factored into the multiple? These considerations can have a substantial influence on the resulting multiple.
Profit
Moving on to the profit side of the equation, we need to determine how to calculate profit. Are we using SDE (Seller’s Discretionary Earnings), EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), net profit, or perhaps a different metric? The choice of profit calculation method can greatly impact the resulting multiple. For instance, using EBITDA might yield a smaller profit number than SDE, resulting in a higher multiple for the same business. For example, a $10 million purchase price with $2 million in EBITDA would give a 5X multiple, while the same business might have an SDE of $2.5 million which would result in a 4X multiple. Despite the business generating the same amount of money, the choice of profit calculation method alters the multiple.
The Best Way to Calculate a Multiple for an Ecommerce Acquisitions
To mitigate confusion and achieve consistency, it is essential to focus on a standardized multiple. One recommended approach is to use SDE, which captures the total seller’s benefit from a business, combined with the cash at closing figure. I refer to this as the “king multiple” since cash is king.
In conclusion, multiples play a crucial role in evaluating business deals, but their calculation can be intricate and prone to manipulation. By understanding the various factors involved, such as the purchase price components and profit calculation methods, one can make informed decisions. Standardizing on a specific multiple approach, such as the cash at closing multiple using SDE, can provide a more reliable measure when assessing business transactions.