Business owners and financial managers love to know what their businesses are worth. One of the most common financial terms referenced when desiring to know a business’s value is its multiple.
There are all sort of multiples referenced in discussions or in the context of industry articles and publications. Some multiples are based on revenues or sales, while others are based on some form of earnings, whether it is pre-tax income, seller’s discretionary earnings, or earnings before interest, income taxes, depreciation and amortization (“EBITDA”). Every so often, there are even multiples based on balance sheet items, such as total assets or book equity. One of the biggest takeaways from understanding multiples is that mixing and matching multiples is a “no-no.” For instance, applying EBITDA multiples to a company’s most recent annual sales can arrive at an incorrect indication of value. Understanding what each multiple is (sales, EBITDA, etc.) and how it is applied to the relevant financial metrics is critically important.
Irrespective of the multiples used to determine a business’s value, business owners and financial managers should avoid gravitating toward multiples that they hear about in country clubs or industry tradeshows. Multiples are not applied uniformly across industries, or even businesses within the industry, for that matter. More often than not, multiples are clouded with recent sales of companies that are not comparable. The fundamental message here is that a multiple is only as good as its underlying data. Being aware of the impreciseness of industry-based multiples is an important component for setting valuation expectations.
Without going too deep into the details, there are a variety of sources that provide empirical data which can be used to produce multiples (some are free, while others are paid memberships). While each source has its own set of parameters and limitations, each provides details about underlying data (otherwise known as “comparables”). Once armed with useful data, business owners and financial managers can sort through the comparables and determine which ones are truly representative of which ones are outliers. Some things to keep in mind when sorting through company comparables are:
- What are the sizes of these companies and how do they compare to mine?
- What is the level of profitability of these companies?
- Are they publicly-traded or privately-held enterprises?
- How recent was the sale?
- Was the sale an asset or stock deal?
- Where are these business located? Are they near my geographic location?
This is not a comprehensive list. However, each of these questions should help select unique comparables, which can then be used to calculate a more accurate multiple.
On the surface, multiples are easy to use. Business owners and financial managers, however, need to know the limitations involved in “multiple analysis.” They also should be mindful that, when seeking an accurate multiple, the devil is in the details, and a little bit of research of comparables can cut a good deal of speculation out of the impreciseness of industry-based multiples.
Have questions about your multiple? Contact our Valuation and Litigation Advisory Services Group at 440-449-6800.