Private equity (PE) investment has brought new attention to valuation in the tree care industry. But not every company will pursue outside investment, and not every owner wants to sell. Understanding value is useful no matter what path a business takes, whether the goal is growth, transition, retirement or simply making better decisions.
So what goes into valuing a tree care business?

Valuating any business requires analyzing what is owned by the operation and how much revenue it generates. What is owned is straightforward and includes the tree care operation’s capital assets, real estate, equipment, inventory, etc. – all offset by liabilities, of course.

Assessing basic worth

This basic valuation – what the owner might receive if the business were sold – can provide a starting point for an operation’s market value.

But a business is usually worth more than the sum of its parts. Customer relationships, reputation, service quality and other intangibles fall under the heading of “goodwill,” and they can add significant value.

That’s why cash flow often plays such a large role in valuation. A steady revenue stream can reflect the strength of those intangible assets and, for many businesses, may have the greatest impact on value.

Using multiples

Many valuation appraisals are simply the result of multiplying the operation’s revenue by the “multiple” for the industry. Multiples for tree care businesses typically range from 2x to 4x the operation’s so-called “discretionary earnings.” The final multiple is determined by the condition of the operation’s equipment, its safety compliance record, the expertise of the staff and the local market.

As with all valuations, a tree care operation’s multiple usually considers how efficient the operation is, how well documented its processes are, how well it adheres to local, state and federal regulations and the stability of its revenue stream. Increased values and premium multiples often reflect specialized services and a loyal customer base.
The businesses that command the highest acquisition multiples are those with recurring commercial contracts and operations that can run without the day-to-day involvement of the owner.

Growth potential

Every valuation can be impacted by the reliability of the reported revenue and the potential for growth over time.

If, for instance, most of the operation’s revenue comes from just one or two customers, the revenue stream would be far less valuable.

On a similar note, if earnings plateaued years ago, it might indicate limited potential for growth or excessive competition in an already saturated market. On the other hand, a steadily increasing revenue stream might indicate the prospect of even more growth resulting from increased investment.

Another option when valuing a tree care business is to look at recent sales of comparable operations. This can provide useful market context, although comparable sales do not tell the whole story. Each business has its own customer mix, revenue history, equipment, staffing, market position and growth potential. Broader conditions, including interest rates and market volatility, also can affect what buyers are willing to pay.

Understanding EBITDA

Earnings before interest, taxes, depreciation and amortization (EBITDA) can be used to determine the value of a business, often serving as a basis for valuation in corporate acquisitions and leveraged buyouts.

PE investors frequently rely on EBITDA to evaluate a business’s overall profitability and financial performance. Most important, EBITDA takes the factors the tree care business can’t control out of the earnings equation.

By excluding costs such as interest and taxes, EBITDA allows investors to compare the core profitability of similar businesses without distortions resulting from different debt structures or tax jurisdictions.

By removing noncash expenditures such as depreciation and amortization, EBITDA provides a clearer picture of an operation’s actual cash-generating power. This is especially true for businesses with heavy-equipment or intangible-asset costs.

A tree care operation’s EBITDA can be calculated using either the business’s net income or its operating income (EBIT). The two most common formulas used by analysts are:

• The Net Income Method: EBITDA = Net Income + Interest Expense + Taxes + Depreciation + Amortization.
• The Operating Income Method: EBITDA = Operating Income + Depreciation + Amortization.

When preparing to sell to a PE firm, tree care business owners often present adjusted EBITDA. This adjusts the core earnings to factor out one-time expenses, such as a major legal fee or a founder’s personal salary, to show what the business’s true, recurring operating power looks like to a potential investor.

Adjusted EBITDA is not the only option when attempting to attract the interest of PE investors. The tree care business must shift from being primarily owner operated to a more salable operation. PE investors usually avoid businesses where the owner is the sole salesperson and top climber. They generally seek a so-called “platform” company that can acquire smaller businesses.

Conclusion

Buyers and investors will look closely at financial performance, cash flow, revenue growth, working capital, debt and the reliability of future earnings. Valuations and financial statements reviewed by a CPA will carry more weight than self-generated figures. Recurring revenue, long-term contracts, a diverse customer base and well-documented operations also can strengthen a company’s value.

PE investors focus on future growth potential; they are not interested in buying a business with flat or declining revenues. In other words, potential buyers look for businesses that minimize risk and maximize returns.

Ultimately, a business is more valuable when it can run and grow without the daily involvement of the owner. Understanding that value does not lead to an imminent sale – it simply puts the owner in a stronger position, whatever path they choose.

Mark E. Battersby is a freelance writer based in Ardmore, Pennsylvania. He has contributed tax and financial articles to TCI Magazine for more than 20 years.

This article is the second in a series designed to help tree care business owners better understand private equity and related transition options. If you have any questions or feedback about this series, please email editor@tcia.org.