The secrets behind Valuation Multiples
Pomanda explains everything you need to know about the secrets behind valuation multiples.
What are valuation multiples?
When a company is sold, its price is often quoted as a multiple. In the context of M&A, a multiple is an expression of the price relative to a financial metric like EBITDA or revenue. For example, if Acme Limited had an EBITDA of £10,000 and was sold for a price of £50,000, we would say that Acme Limited sold for a multiple of x5 EBITDA.
A valuation using multiples operates on the theory that a company’s value is relative to the value of other companies in the same industry. It is often the chosen method for valuing companies because it is simple to calculate and is contextualised given the industry and the timing of the sale. Other valuation methods like discounted cash flow (DCF) are theoretical in their approach and need the user to make detailed assumptions about the company’s future cash flows, arguably muddying the water. And require both a detailed knowledge of the business and some Excel horsepower.
What’s the right valuation multiple for my business?
What’s really important when using a valuation multiple to work out the value of your business is using the correct multiple. Multiples vary enormously across industries so being honest about the industry that you operate in is vital to getting an accurate valuation. If you meet a potential investor and claim that your company should be valued at a Snapchat style 28x multiple, you’ll be laughed at. Which isn’t fun!
Many companies and journalists will simply use a 10x multiple on a company’s EBITDA as a ready reckoner to work out the value of an operation.
But don’t be part of the herd (hence the sheep image in the blog heading!) as the devil is in the detail. If you are a fashion retailer such as Next plc, your valuation if you were solely a bricks and mortar operation would be worked out on a 4.7x multiple If you were a pure online retailer, you would use a 10.4x multiple. That clearly makes a massive difference to your valuation. The reality is that in the case of Next plc is that you are a blend of these two numbers. So it’s important to think carefully about the industry you operate in when coming to your valuation.
At Pomanda. we’ve made it easier to work out the value of the company (be it yours or someone else’s) by providing a detailed list of all the multiples, by industry. Simply enter the name of the company, Pomanda then extracts the most up to date data from Companies House and applies a multiple based on the industry code that the company has submitted in its accounts. If you think that this isn’t a true reflection of a company’s activities, simply add industries and/or adjust the weightings for a revised Guide Valuation.
Are valuation multiples the best way to value a company?
There are many people who believe that valuation using multiples is far too simplistic to be effective. While DCF requires assumptions to be made correctly, basing your valuation on what other companies are valued means you’re relying on other people to correctly value those companies. In addition, finding a comparable company is a challenge because no two companies are exactly alike. This is especially onerous when trying to value a private company because they’re not required to publicise the sale price, making it difficult to find a suitable company.
It should be noted that valuation multiples in their simplest form are not particularly useful to young companies, like start-ups, because they require EBITDA or revenue to work. For these companies, Professor Aswath Damodaran of NYU Stern suggests that it’s possible to ascertain the value of these companies by estimating future revenues and discounting back. You can read more about this here
If you’d like to see how these valuations differ across different methodologies, you can try out our business valuation calculator for free. Value your business or a competitor and get instant company valuations at the click of a button.