Assessing Reasonable Pricing for Private Enterprises

Valuing private companies is more challenging than valuing public ones due to the absence of audited financial statements, which forces buyers to invest significant effort in uncovering accurate earnings information. Historically, closely held companies sell for about one-third less than their publicly held counterparts.

Buyers using EBIT (Earnings Before Interest and Taxes) as a valuation metric typically avoid paying high multiples for companies that offer little more than bare bones. They expect at least 50% of the purchase price to be supported by working capital and tangible assets, including machinery and equipment. Buyers prefer acquiring a going concern, especially if paying full price, to run the company without needing further infusions for working capital or capital equipment.

Determining a reasonable acquisition price involves scrutinizing the seller’s facilities and assessing its capital needs and working capital adequacy. Professional buyers are pragmatic and do not heavily invest in optimistic projections. They seek assurance that budgeted depreciation will cover necessary capital expenditures and that EBIT will remain stable in the following years.

Valuations often revolve around current EBIT multiples, similar to price-earnings multiples of public companies, with relevance tied to growth rates:

- A 10% growth rate might correspond to a 4-5x EBIT multiple.

- A 15% growth rate might justify a 5-6x EBIT multiple.

- A 20% growth rate might command a 6-7x EBIT multiple.

However, these valuations must be tempered by market realities, where well-financed buyers vie for a limited number of excellent companies. The market ultimately sets prices, and sellers often settle for less than initially desired, while buyers might pay more than expected. In this competitive environment, obtaining a reasonable price for private companies remains a significant challenge.