What are valuation 'multiples'?

When in the early stages of selling a business, much of the chat is focused on the valuation 'multiple' that you might get from a buyer.

You'll hear things like:

"Did you hear Pete got 20x forward earnings on his sale?"
"You've gotta get the buyer to pay a revenue multiple."
"There's no way you can get 10 times EBITDA in this market."
"We're growing super fast so we got a 15x multiple."

But what is a valuation multiple, how is it calculated and when is it used?

Let's dive in.

What is a valuation 'multiple'?

A multiple is a ratio between your company's financial metrics (such as earnings, revenue, or cash flow) and it's value.

The most common formula to calculate the price offered to buy a business is: 

You choose a financial metric of the company, and scale this up by a 'multiple' to give you the price for the exit.

So if you have a business making £5m of EBITDA per year, and the buyer decides that an 8x EBITDA multiple is a fair price, then the price offered is £40m.

In practice, this means that if the EBITDA stays flat the buyer will have recouped their money (before interest costs, tax and depreciation) within eight years. If the business is growing quickly, that will be much sooner and vice-versa.

How is the calculation used?

This calculation is run by both the buyer and the seller to give a ballpark figure or range for the price at which they might do the deal.

It helps both sides to know that the price is in line with what is normal / conventional in the market, and that they're not getting a terrible deal.

So both parties will come to the table with a multiple in mind, and use that as the starting figure for their negotiation. They will often refer to the multiple as justification for the desired price, using examples from recent similar deals as evidence of why this is fair.

Obviously as a seller you might think your business deserves a higher multiple, but if both parties are reasonable and well-advised these two numbers should be close enough that can make a deal happen.

Which financial metric?

Most commonly, this is the last full year's EBITDA.

That's Earnings before Interest, Tax, Depreciation and Amortisation.

This gives you a sense of the profit of the business, ignoring the costs of interest, tax and depreciation / amortisation.

There's no great science behind this, but it has become the standard metric on which most valuations are done.

But, other financial metrics can be more appropriate based on the stage and size of the company. This can be:

• Revenue: If you are loss-making, there is no EBITDA on which to apply a multiple. In that case, revenue is the only available metric. Young start-ups and very fast-growing companies will also argue for revenue to be used as they have not yet shown the extent of their profitability.
• Last 12 months or forecast: If the business is growing fast, you might argue that too much has changed since the last year and so more recent numbers should be used. This is also true is the company is in the final quarter of its financial year. If so, you can use the last 12 months of actuals, or the forecast for the current year.
• Net profit: For companies with very high interest costs or lots of depreciation (in asset-heavy industries), the "ITDA" in your EBITDA may be significant. That makes a large disparity between the EBITDA and net profit, so net profit or Net Profit Before Tax might be a more appropriate measure.
• Free Cash Flow: FCF may also be more suitable than EBITDA where the company needs high CAPEX investment and so has lots of depreciation.

"Adjusted EBITDA"

It might be appropriate to make certain amendent

• Your salary and perks
• The salary and perks of any family members to market value
• Market rent price if you are the owner of the facilities and don’t pay for it
• Personal expenses (e.g., mobile phone, childcare, travel expenses)
• Expenses or income that isn’t expected to continue after the sale 
• One-off events
• Discontinued operations

Adjusting EBITDA helps obtain a normalized and accurate figure not impacted by irregular gains, losses, and other factors. Failing to adjust EBITDA may result in an incomplete representation of your company’s true earnings potential, leading to a lower valuation

Which metric should I argue for?

If any of the above factors apply to you, you might want to argue that you should be valued on a different basis to usual.

In your Information Memorandum, or other communications with a potential buyer, you might mention something like:

"Based on the focus on rapid growth rather than profitability, we believe the business should be valued on a revenue basis."

If you are working with an advisor, they will be able to help you work through this.

When multiples don't matter...

There are some cases when the notion of a multiple goes out of the window.

This is usually because the buyer is not buying you for your financial performance, but for other reasons.

You might be an IP or asset-heavy business, where the value comes in patents you own, technology you have built or some other infrastructure you own. Maybe you are also uncommercialised at the point of sale, meaning that you have no revenue (and obviously negative EBITDA). Clearly then the buyer wants you for something else!

The classic example here is Facebook's $1b acquisition of Instagram, before it had earned a dollar in revenue.

You then can throw the whole concept of multiples away. The price then becomes 'whatever a buyer is prepared to pay' - more similar to valuing a piece of rare art than a business.

This can be dangerous territory for an owner as there is no safety of a multiple range to fall back on. The best advice here is to get multiple bidders interested, and probably run an auction process, to get the best price possible.

Other valuation methods

The second most common valuation method is called a 'discounted cash flow' analysis.

We'll save a DCF deep-dive for another day, but in essence you forecast the future cashflows of the business in perpetuity, they 'discount' these to get their value today and use this as a ballpark for the price you should pay.

This is more common in mature business with a long track record or steady cash-flow generation, like a utilities or infrastructure business.

This gets technical quite quickly, with the conversation focused on terminal values, discount rates and cost of capital. If your buyer is referring to DCF in your negotiations, you should speak to an advisor who can help you through this.

Alternatively, an asset valuation will add up the value of the companies individual assets. That includes real assets like property and machinery, and intangible like IP and patents. You then subtract any liabilities. This is only used in asset-heavy businesses like manufacturing or engineering.

How do I get a higher multiple?

It goes without saying:

Of course, financial metrics are difficult to change significantly. It takes years of sweat and toil to double your profit! But the multiple can be more easily influenced in your favour.

The more you can convince the buyer that you are a great bet to keep growing, maintain or increase profits, defeat competition, increase prices, keep key team members and avoid pitfalls around tech, IP or tax… the higher your multiple will be.

There's a lot to get into here, so we've broken this down in a separate article. We'll get into the detail of what drives a multiple higher, and what suppresses it, and give you actions to maximize the multiple for your business on an exit.

What multiple can I expect?

So, the (multi) million dollar question is: What multiple could I expect for my business?

We've broken that down in a separate article too, looking at common ranges for multiples.