Advisory M&A ROI is Getting Crushed by High Rates and Record Multiples
Advisory M&A ROI is Getting Crushed by High Rates and Record Multiples
In this article we’ll cover how the investment costs have skyrocketed for acquiring the same practice today than just several years ago. A large percentage of advisors we speak with have a bit outdated perceptions of the benefits of an acquisition. An advisory acquisition can still be the best way to grow it’s just the returns aren’t nearly as attractive in this current environment. We are starting to wince at the deterioration of free cash flow and ROI we see in deals today compared to a few years ago. Today the anticipation of a healthy CAGR is more of a critical factor than ever for justifying some deals. When breaking out case study examples two new rules of thumb emerged:
New General Rule: One revenue multiple point is equivalent to 5 interest rate points. The cost difference between paying a 2.5x revenue multiple versus a 3.5x multiple is equivalent cost increase equivalent to about a 5% increase in the interest rate of the acquisition loan.
New General Rule: Acquisitions where an advisor uses an M&A broker or marketplace and pays a 6% broker fee and a 15% premium on price on a 3x valued practice is the same as the buyer paying 20% of the seller's revenue in an EXTRA premium price. And that's if the deal was paid all in cash and not financed (not an often occurrence).
Acquisitions Can Cost 50% to 68%+ More Today Than a Few Years Ago
Just a few years back when multiples where 2x to 2.6x and the interest rate was somewhere in the 6% range the concept of a practice paying for itself just from a modest CAGR was a no brainer. A few years ago you could acquire a $1M practice for 2.5x for $2.5M at 6.5% rate. The total interest paid is $900K. This $1M revenue practice example costed $3.4 million with interest cost factored. It’s a different story today.
Today the same $1M recurring revenue practice if sold for 3.5x at current rates:
8% rate (conventional loan neighborhood): $1.6M interest
10.5% rate (SBA loan neighborhood): $2.2M
With the now $3.5M purchase price plus $1.6M to $2.2M in interest the investment skyrockets to $5.1M to 5.7M for the same practice that went for $3.4M investment a few years ago.
Yesterday (few years ago) the $3.4 million investment to buy $1M revenue now costs about $5.1 to $5.7 million.
This acquisition investment costs for this practice have risen from at least 50% to 68% for the same practice than if purchased 4 years ago. But, this is only accounting for financing costs and not premium pricing and broker fees. For those buyers who are using a M&A broker there is a premium to be paid.
High interest rates and record multiples are washing away ROI
It’s no surprise that for most acquisition deals its the cost of financing which is the biggest premium to the purchase price paid. However, the rise in the multiple carries significant more weight than the interest rate. This resulted in another new general rule discovered in acquisitions: One multiple point is equivalent to an increased cost of 5 interest rate points. The cost difference between paying a 2.5x multiple versus a 3.5x multiple is equivalent to a 5% increase in the interest rate of the acquisition loan.
It gets worse with M&A broker fees and premiums
Most M&A brokers will charge anywhere from 6% to 10% of the purchase price as their success or placement fee. Unfortunately, this often isn’t the biggest cost of using a broker because about all of them brag on the seller facing pages of their websites that they typically get their sellers anywhere from 17% to 20% or more in premium pricing. So that $1M value practice they will get $1.2M for and instead of 6% to 10% of $1M the fee is on the $1.2M premium price. Ironically these highest priced practices are not higher value than direct acquisitions.
New General Rule: Acquisitions where an advisor uses an M&A broker or marketplace and pays a 6% broker fee and a 15% premium price on a 3x valued practice is the same as the buyer paying 20% of the seller's revenue in an EXTRA premium price. And that's if the deal was paid in cash and not financed.
How acquisition premium costs look today:
Buying Direct + Loan
Premium Pricing 39% to 68%
Buying without a broker with 100% bank financing
Valuation: $1 million
Price: $1 million
100% conventional 7-8% rate loan add 39% to 45%
100% SBA 10-11% rate loan add 58% to 68%
Broker + Loan
Premium Pricing 47% to 75%
Buying with broker, without seller premium, and 100% bank financed
$350,000 Recurring Revenue Book
Valuation: $1 million
$1,000,000 Purchase Price
$60,000 Based on 6% Broker Fee
$1,060,000 Gross Purchase Cost
Gross Practice Premium Paid: add 6%
Conventional Loan: 100% conventional 7-8% rate loan add 41% to 48%
Total of 47% to 54% premium costs with Broker + Conventional loan
SBA Loan: 100% SBA 10-11% rate loan add 62% to 69%
Total of 68% to 75% premium costs with a Broker + SBA loan
Broker + Seller Premium + Loan
Premium Pricing 77% to 110%
Buying With Broker Plus Seller Premium
$350,000 Recurring Revenue Book
Valuation: $1 million
~20% premium price they share they get for their represented sellers
$1,200,000 Purchase Price
$72,000 Based on 6% Broker Fee
$1,272,000 Gross Purchase Cost
Gross Practice Premium Paid: add 27%
Conventional Loan: 100% conventional 7-8% rate loan add 50% to 58%
Total of 77% to 85% premium costs with a Broker + Seller Premium + Conventional loan
SBA Loan: 100% SBA 10-11% rate loan add 74% to 83%
Total of 101% to 110% premium costs with Broker + Seller Premium + SBA loan