The concept of run rate
There is no common literary definition of run-rate. As a result, run-rate analysis can be highly subjective. For this reason, when professional service firms produce run-rate calculations within M&A reports; a disclaimer is always incorporated.
However, the purpose of run-rate is to reflect both current and known performance to produce a P&L reflective of the state of the business in the near-future once known/secured benefits and costs have been considered.
In some M&A transactions, buyers may be asked to make bids based on the EBITDA run-rate as opposed to an adjusted EBITDA figure based on actual results. For example; consider a technology business which sells software with annual recurring license fees. In such a business, annual recurring revenue (‘ARR’) is a key valuation consideration and thus it may not make sense to utilise adjusted EBITDA because the latest full year results would not incorporate a full year of value for any new customer contracts.
Starting point for run rate calculation
The starting point of the run rate calculation is often Adjusted LTM EBITDA (i.e. EBITDA for the last twelve months, adjusted for any one-off revenue/costs). However, other methods can be used. For instance; some firms prefer to build the run-rate EBITDA on a more granular basis; making individual assumptions for revenue, margin and overheads to arrive at an adjusted EBITDA figure.
As run rate is more an art than a science, it is easy to make arguments to use different methodologies. For instance, if there has been a fundamental change in the business such that LTM is not an accurate reflection of the position going forward, you could annualise the last six months performance.
Typical run rate adjustments to EBITDA:
- Full year impact of losses in LTM
- Full year impact of wins in LTM
- Benefit of wins confirmed but not started in LTM (typically require contractual arrangements in place to give credit)
- Non-recurring work – was there a particularly high/low level? Could make adjustment to reflect a ‘normal’ level. Level of judgement in this.
- Pay increases – if pay increases were implemented part way through the LTM period, an adjustment should be made to push back the pay increase to the start of the period.
- Headcount – starters/leavers. E.g. any unusual leavers who were on particularly high pay and will not be replaced? Or have there been a lot of new staff taken on that will be required going forward?
- Any significant one-off costs/income incorporated within the starting run-rate position? E.g. if costs are calculated by the most recent month * 12 – is there anything odd or exceptional being posted in that month?
- Bonus – was a particularly high/low rate paid? What would be expected going forward?