Question: Have you heard of EBITDA multiple erosion?
EBITDA multiple erosion is the process where the buyer has exclusivity with the seller (after the letter of intent is signed) and begins the financial due diligence process. All the negotiation power moves from the seller to the buyer during this period and this is when the buyer begins to drop the purchase price because of weaknesses discovered in the financial records of the seller.
A simple example may help. Let us assume the seller has $1.0MM in EBITDA and receives an offer to purchase at 5x EBITDA or $5.0MM in purchase price. As the buyer moves through the financial due diligence period, weaknesses are discovered in the seller financial records, and the buyer drops the price to $4.5MM. The seller lost $500 thousand in purchase price or .5x in EBITDA multiple.
What if I offered to sell you insurance to protect $500,000 of purchase price at a cost of $50,000? Interested?
That is what a seller-side due diligence achieves. We perform a financial due diligence in the same manner as the buyer to identify weaknesses in the books and records of the selling company.
Typical areas we analyze are:
- Cost of revenue
- Selling and marketing expense
- General and administrative expense
- Other (income) expenses
- Cash requirements
- Working capital accounts
- Fixed assets
- State and local tax issues
- IT environment
- HR environment
- Management prepared forecasts or budgets
We recommend contacting us two to three years before the transaction date because time is needed to identify and fix any issues before the company is listed for sale. An added benefit is that every document we request can be stored in a data room for future reference when the buyer does do a financial due diligence. We know time kills all deals, so the ability for you to pre-load documents into a data room is very helpful to the deal timeline.
Mike Metzler, CPA, ABV, CMA, CGMA, ASA, Director