MSP EBITDA Valuation Multiples: What You Need to Know

EBITDA stands for earnings before interest, taxes, depreciation and amortization. It’s an extremely useful measure of a company’s operating profitability and a key valuation metric for private equity firms, banks and other investors considering buying a company or financing its future growth. The EBITDA valuation multiple is the price tag an investor puts on that company’s EBITDA; in other words, how much value does it assign to its EBITDA? If you’re thinking about investing in a small business, it’s helpful to understand how investors evaluate its value. Read on to learn more about EBITDA valuations and their significance when evaluating potential investments in small businesses.

Why do investors use EBITDA Multiples?

## Why do investors use EBITDA multiples to value a company? EBITDA is a pretty simple metric, but it’s actually not the only valuation metric investors consider. But it is the most common and relevant metric for MSPs. In fact, all other valuation metrics rely on EBITDA as a key starting point. So first, understand that when analysts, investors and bankers discuss a company’s valuation, they’re really talking about its enterprise value.

Enterprise value is the total value of a company, including its equity and debt. How much investors will pay for a percentage stake in the company’s equity is the company’s valuation. To calculate enterprise value, analysts start with the company’s EBITDA. They add back the interest and taxes associated with the company’s debt and subtract the depreciation. This produces the company’s enterprise value and it’s the basis for all other valuation metrics.

Why do investors use EBITDA multiples to value MSPs?

As mentioned above, EBITDA is the key metric investors use to value a company. The same logic applies to MSPs. The difference is that MSPs don’t have equity as part of their valuation. MSPs are simply service providers, so they don’t have tangible asset book value equity to be valued. Instead, investors use EBITDA multiples to determine how much they’re willing to pay for a stake in the company’s stream of cash flows through a combination of debt and equity. This is an important distinction. It’s important to note that the same factors that drive up a company’s EBITDA also drive up an MSP’s EBITDA. Higher demand, productivity improvements, and more efficient use of capital all drive up a company’s EBITDA. Similarly, these factors also drive up an MSP’s EBITDA.

What is an MSP EBITDA Valuation Multiple?

For a private equity firm, bank or other investor to value a MSP and determine how much to invest in the company, they first need to determine what percentage of its revenue they’d like to receive as their share of its cash flow. This percentage is known as the equity multiple. The investor calculates the MSP’s EBITDA multiple by dividing the enterprise value by the company’s EBITDA. The EBITDA multiple is the same thing as the EBITDA valuation multiple.

Confusion over EBITDA and MSP EBITDA Multiples

While EBITDA is the metric investors use to value a company, MSPs don’t have equity for investors to value. So why do investors use the same metric to value MSPs? There is actually a close tie between how much investors are willing to pay for a piece of a company’s revenue stream and the amount of equity they want in the company. The equity multiple is simply the percentage of a company’s revenue an investor is willing to take. So investors use the EBITDA multiple as a basis for determining equity multiples because they’re basically the same thing. They’re both used to determine how much money investors are willing to pay for a stake in a company’s cash flow.

EBITDA Valuation Multiples by Company Size

Now let’s take a look at how EBITDA multiples vary based on company size. Generally speaking, EBITDA multiples are lower for smaller companies compared to larger companies. Why? Because investors often have a higher risk tolerance for larger companies than their smaller counterparts. As a result, they’re willing to offer a lower EBITDA multiple for smaller companies. Why? Smaller companies are riskier investments, so investors want a higher return on their investment. In other words, they want a higher EBITDA multiple. But larger companies are less risky, so investors are willing to pay a lower multiple for their EBITDA. This may sound contradictory to what we discussed above: the same factors that drive up a company’s EBITDA also drive up an MSP’s EBITDA. But there is an important difference: a larger company already has a significant amount of revenue. So investors are less concerned about whether the company will be successful.

Limitations of the MSP EBITDA Valuation Multiples Calculation

There are a few limitations to relying solely on the EBITDA valuation multiple calculation. Because it’s a broad-based calculation, it can be difficult to compare two companies with different industry segments. Let’s say two companies in different industries each have an EBITDA multiple of 10. While this might sound like a good thing, it doesn’t necessarily mean that both businesses are equally attractive. The metrics that feed into the EBITDA multiples are different for each industry. It’s more useful to compare EBITDA multiples between companies in the same industry. Even then, it’s important to understand the underlying drivers of each company’s EBITDA multiple. Otherwise, it can be hard to determine which company is more attractive. ## When shouldn’t you rely on an MSP EBITDA multiple to value a company? There are a few scenarios when you shouldn’t rely on an EBITDA multiple to value a company. First, if you notice that the EBITDA multiple for a certain industry is higher than average, this may indicate that the industry is in high demand. In this case, you might want to consider investing in a company in that industry even if its EBITDA multiple is above average. Similarly, if you notice that a certain industry has an unusually low EBITDA multiple, this may indicate that the industry is experiencing downward pressure on pricing. In this case, you might want to consider investing in a company in that industry even if its EBITDA multiple is below average. This can be an effective strategy for finding deals in an otherwise tight market.

5 Key Takeaways

EBITDA is the key metric investors use to value a company, and it’s also the metric they use to value MSPs. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. The EBITDA multiple is the price tag an investor puts on a company's EBITDA and is the basis for all other valuation metrics. Investors use EBITDA multiples to value a company by dividing the enterprise value by the company’s EBITDA. This produces the company’s EBITDA multiple, which is the same as the EBITDA valuation multiple. EBITDA multiples vary based on company size, with smaller companies generally having lower multiples. There are a few limitations to relying on the EBITDA multiple to value a company. ## When you understand how investors value a company, you can make better investment decisions. It’s important to understand the EBITDA multiple and how it’s calculated. With this information, you can make better decisions regarding your investment strategy.