RULES OF THUMB
Thinking about valuation is bound to be affected by the traditional “rules of thumb” that are frequently repeated in conversations about M&A. For instance, you often hear the statement “We’ll pay between five and seven times for a company.” This calls for explanation. Five to seven times what?
Normally, what’s referred to here is EBITDA: earnings before interest, taxes, depreciation, and amortization. EBITDA provides the closest proximity to actual cash flow. Paying five times EBITDA is another way of saying that you expect a 20 percent return on your money. That’s to say, you expect to get $1 for every $5 that you invest, with all your money returned within five years. So when buyers speak of paying five to seven times EBITDA, ...
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