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 require the user to make detailed assumptions about the company’s future cash flows, arguably muddying the water.
However, 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.
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.