Payback period for M&A

[Grentropy]

We’re helping a client evaluate various companies for acquisition. One of the criteria they are particularly interested in is the straight payback period. I’ve used payback period when doing capital budgeting, but never really used it for M&A transactions, and I’m having trouble finding any resources that would give an idea of what a reasonable or average payback period would be. The client wants 5 year payback, but that doesn’t seem realistic based on pretty much every other valuation metric (NPV, sales and EBITDA multiples, etc…)
So any idea where I can get a better sense of what industry averages might be, or at least some kind of rule of thumb on what the maximum should be?

 

[CFAvsMBA]

It’s client specific. I was in Corp Dev for awhile and payback was looked at prior to NPV since the CEO was risk adverse and felt most models that Sell Side guys showed him were GIGO. We’d model regardless, but payback was clutch and it was expected in three years or less in case assumptions didn’t pan out.

 

[higgmond]

I suppose you could look to private equity for some guidance. They target an exit in 3-5 years, albeit with an expectation for both margin and multiple improvement over that time. I’m in business valuation and do a lot of purchase price allocation and can’t remember a single corporate client talking about payback period as a factor in the acquisition decision.

 

[Grentropy]

Just wanted to say a belated thanks to both of you for the responses, I ended up traveling last week and am just seeing these now. Our client is from an EM, and is fairly risk averse. They’ve had pretty strong organic growth over the years, but are pretty limited in their M&A experience. Regarding PE groups, I know they target an exit in 3-5 years, but I assume that generally exit/payback is expected from whoever they sell to (another buyer or IPO) and not directly from the companies cash flows?

Right now to help mitigate risk and incentivize the manager-owners, the client is considering a proposal where they will take a majority stake in the company based on valuation today, and then use a predefined earnings multiple to buy the remainder in a couple of tranches. While I like the idea, I’m having trouble coming up with the right metrics to use that are relatively straight-forward yet resistant to manipulation. Anyone have experience with an earnout structure? Any advice on things to do (or more importantly things to make sure not to do)?