Valuing a Services Company
Question:
Is there a general range of how many multiples of earnings a service company is worth? I’m hearing between 1.5 and 2 times revenue is very basic and fair usually.
Answer:
It depends first on the industry. And then the company’s subset in the industry.
So, in the services industry, valuation of an accounting firm is different from a law firm, is different from a technology firm, is different from a medical practice. If you are a technology firm, then it depends on what type of technology firm. Are you a software developer? A service company? A combination of both?
Then you should look at quality of earnings. What percentage of revenue is written off to bad debts? What percentage is 30, 60, 90, 120 days’ collectible? What percentage of billings are one time engagements vs ongoing legacy engagements? What percentage of ongoing legacy engagements are 2 year, 3 year, 5 year, indefinite contract periods?
Then there is the company’s debt. How much debt exists? What are the debt covenants? What is current vs non-current? Then there are the lease terms for the operating lease. When does the lease expire? What will future rent be?
These are just some of the factors that are looked at when coming to a final number.
So, a company may fall into the 1.5 to 3 times revenue bucket based on the industry it is in. But upon due diligence, when all of the above items are factored in, it may end up settling at 2 times revenue.
Point being that the industry standard for a company may be, say 1.5 to 3 times revenue. But that is just a starting point for the conversation. Once you get through due diligence and factor in the specifics of the company that gets drilled down to a more specific number. And that factor amount is the basis for valuing that specific company.