A key metric to know when selling your business is your business valuation multiple. This is a method of valuation where you determine the potential future earning power of your company by assigning a multiplier to your current revenue or earnings benchmark.
The business valuation multiple is based on the idea that similar companies sell at similar prices, and so it looks at the value of comparable companies in your space and also at recent company sales in your industry. The multiplier assigned depends on the industry, the state of the economy, and many other factors.
In this article, we are examining the business valuation multiple from different angles so you can understand how it fits in to the larger business valuation picture.
Common Types of Business Valuation Multiples
In general, there are two main methods commonly used for business valuation multiples.
The first are Enterprise Value (EV)-Based Multiples. These are the multiples typically used in M&A, and they allow direct comparison between different firms. Here are a few examples of EV-based multiples:
- EV/ Earnings Before Interest, Tax, Depreciation & Amortization (EBITDA)
- EV/ Net Operating Profit After Adjusted Tax
- EV/Net Sales
- EV/Operating Free Cash Flow
- EV/Invested Capital
- EV/Capacity Measure
In contrast, the second type are Equity Price-Based Multiples that examine ratios between a company’s share price and a performance element. These are usually used when acquiring minority stake in companies, rather than full transactions.
- Price/Cash Earnings
- Price/Book Ratio
- Private Equity Ratio
- Prospective Average Earnings Growth Ratio
- Dividend Per Share/Share Price
Approaches to Business Valuation Multiples
Now that we have covered the types of multiples used, let’s look a little deeper at the two main approaches to business valuation multiples.
The ‘Comparable Company Analysis’ is used compare similar companies in your industry. The valuator will analyze companies that are similar to yours by gathering share prices, capital structure, revenue, EBITDA, and other reverent information for each company and comparing the results.
The ‘Precedent M&A Transactions’ method analyzes past M&A transactions for companies in the same industry. That is then applied as a reference for the company being valued.
Advantages of Business Valuation Multiples
Applied appropriately, multiples are an advantageous way to help valuation professionals make defensible estimates and analyze a company’s financial status. They are relevant to analysis because they use key company data and statistics, and in general they are simple to apply for most analysts.
Limitations of Business Valuation Multiples
As with any one method of valuation, there are also drawbacks. The simplicity of a simple math equation often doesn’t consider all the variables. Two companies can have similar profits, but completely different debt structure or asset profiles. Multiples can also be too static and based on short term forecasts to accurately predict future performance.
Free Business Valuation Calculators and Multiples
Be careful using these valuation tools. Because free business valuation calculators online often use multiples based on available industry data – i.e., publicly traded companies, the accuracy of the calculator may vary based on how alike your company is to large public companies. While attractive in their simplicity, chances are you won’t get a terribly accurate picture. It’s always better to leave the valuating to the professionals who can incorporate the actual nuances of your business and financials into their valuation, rather than an algorithm.
We hope this article was helpful to you in learning more about business valuation multiples. Multiples are a common valuation method, and one part of the larger valuation process.