Unlocking Value: Run Rate EBITDA Adjustments in HOA/Condo Management

Previous posts have covered both the use of EBITDA as a financial metric used to value HOA and condo management companies, as well as certain customary and negotiated EBITDA adjustments in a transaction. We will add to that base of knowledge by covering run rate adjustments.

Run Rate Adjustments

Run rate adjustments to EBITDA are typically framed as last-twelve month changes to the business that have created or eliminated value, but are not entirely reflected in the LTM P&L. These can range from new client wins or losses to ancillary revenue streams. Let's do a few examples. First, let's start with a basic P&L:

The Owner of Company A wishes to sell her business, and the last twelve months P&L indicates an EBITDA figure of $1.1M. However, Company A's numbers don't fully reflect a few recent changes in the business:

- Company A just signed a new onsite client worth $60k annually (net revenue)

- Company A recently hired a new VP of Client Services, a newly-created position that is necessary to maintain current and anticipated performance

- Company A recently won a large portfolio client, which generates $4k per month in portfolio management fees

Run Rate Adjustment 1 - Accounting for New Client Win

If Company A's financials don't yet include any benefit from its new client win, the Company is potentially justified in adding the $60k to its financials as the buyer will inherit the benefit of the client win. Furthermore, Company A could also make a case that it should add in any estimated association fees, transfer/escrow fees and software reimbursements should also be included, but would likely need to provide detailed support to back up that assertion. A sell-side representative would assist in creation of those analyses, but for the sake of this analysis we'll make basic assumptions that the fees generated are $15k for each of transfer and escrow fees, and $25k for software reimbursement.

Run Rate Adjustment 2 - Recent Necessary Hire

Company A recently hired a VP of Client Services, who earns $100k across payroll and benefits. The P&L above reflects one month of such person's pay burdening the financials. As such, Company A adjusts its financials to add another 11 months of the VP of Client Services' payroll and benefits to reflect a full 12 month burden. Since the hire is necessary for any buyer to grow and sustain the business, the case for not including as a run rate adjustment is weak.

Run Rate Adjustment 3 - Recent Portfolio Client Win

In addition to its recent onsite client win, Company A also recently won a significant portfolio client, worth $4k per month, or $48k annually. If Company A's financials don't yet reflect this win, the Company should add the $48k of revenue and (as mentioned earlier) also work with its advisor to estimate association fees, transfer and escrow fees, and additional software reimbursement associated with that client win (for ease of analysis, we estimated each simply in the graphic below). Critically, Company A should also add direct costs estimated to serve this new client. This estimate can be conducted in a number of ways but should include some time estimate of its CAMs' time and accountants' time as well as potentially some further burdens (overhead, administrative time allocation). For the sake of this analysis, we'll assume that portfolio client margins are 40% (after CAMs) and that the associated accounting lift for this new client is ~$10k annually.

Summary Implications

After reviewing its run rate adjustments, Company A's EBITDA is now $1.15M, not the originally-stated $1.08M. While the difference may seem small, keep in mind that investors pay a multiple of EBITDA for management companies, and so that difference can expand valuation significantly.

The concept of run rate earnings is very common in private equity purchasing. As a result, paying for earnings that have yet to materialize (but are likely to do so) allows private equity to pay more for businesses than a typical buyer may do. Furthermore, and we will cover this in a later post, private equity financing sources (direct lenders) can often underwrite such adjustments as part of the third-party debt used in a PE buyout. Traditional lenders (banking institutions) will be far more conservative, utilizing only historical earnings to generate the available debt financing.

For more information on the HOA management industry, valuation metrics, or other questions, please contact contact@camadvisors.co or visit camadvisors.co.