Are you selling your company? Want to know how much you should sell it for? Don’t rely on valuation multiples to value your company.
Would you pay $20,000 for a car just because an acquaintance (not even a friend!) purchased a car for that same price? It could be or could not be a totally different brand, year produced, and accessories for that price. If you said “yes,” stop reading. Send me an email. I will buy your company!
One of the most frustrating things to see is owners of small to medium sized companies relying on rule of thumb valuations based on multiples. It is evident why this method is attractive, it is simple to apply and easy to understand. However using this valuation method doesn’t take into account key characteristics of your business and you could be leaving a lot of value on the table (if you are selling) or paying too much (if you are buying).
So what exactly are Valuation Multiples?
Valuation multiples are ratios calculated from financial data selected from your target industry (ie if you have a cafe, you would look at coffee companies and multiplied by a variety of different elements in your financial statements.
Sources of Valuation Multiples:
- Trading Multiples: Obtained from stock exchange data of publicly listed companies. Look up your companies in the search functions of Google Finance or Yahoo Finance , you will see some multiples already calculated (be very very careful using these multiples, often they are not adjusted for the needs of valuation purposes). Products like Factset and CapitalIQ do an excellent job of organizing the information in a verifiable manner.
- Acquisition Multiples: Acquisition multiples are often more difficult to find as generally acquirers and sellers are hesitant to broadcast to the world the details. The exception is when one of the companies is a publicly traded company (target or acquiring company). They need to report limited transaction details with limited amount of information. You can find this information within the SEC filings for company.
Below is a list of the most used valuation multiples and the industries which typically utilize them.
Types of Valuation Multiples:
|Multiple||Used in which sector|
|Enterprise Value ("EV") / Revenue||Various|
|EV / Subscriber||Cable TV / Internet Companies, Online Services & Products with monthly payments|
|EV / EBITDA||Various|
|Market Cap / Book Value||Technology , Banks, Insurance Companies|
|EV / FFO||Real Estate|
|P / E (Price / earnings)||Various|
|PEG Ratio (PE / Annual EPS growth)||High Tech Companies|
Why shouldn’t you NOT use Valuation Multiples for the sale of your company?
1. Trading Multiples are not really relevant for the sale of your company
If you are looking at purchasing a small / medium size business and the value justification is based on trading multiples of public trading companies, I recommend using a visible “are you serious” expression.
- Bigger is better (lower risk profile): Public companies are typically larger and thus present a lower risk to investors. This increases their value in relation to their financials. Ej. Starbucks has 21.000 stores. If one Starbucks Café doesn’t work out, it will barely move the needle on profitability. If your one café doesn’t work out, your whole business will be impacted.
- Larger Diversification of products / geographies (lower risk profile): Public companies generally have a larger diversification of products than private companies which will result in a large valuation relative to financials. Ej. Starbucks has stores in 65 countries, sells lunch and breakfast in addition to Starbucks branded merchandise. Your café only sells coffee. An increase in the global coffee price would impact your returns more than it would impact Starbucks.
- Different Accounting Strategies: Public companies present their earnings to maximize certain ratios (possibly due to misguided incentive packages for their executives). A private company would have to adjust some of its accounting in order to be sure that the multiples are comparable.
- More Liquidity: The ability for an investor to withdraw and invest at will also presents a lower risk for the investor, and thus increases value in relation to financials. If an investor in Starbucks sees a downturn in people drinking coffee they can simply sell their stocks the next day, an investor in a single café does not have the luxury of a quick sell.
2. Acquisition multiples for companies are highly variable
Your company is almost very different from other companies in the same industry. Using the average multiple of an industry doesn’t take in the following VERY IMPORTANT characteristics which can impact your valuation significantly.
- Acquisition Multiples doesn´t consider position on growth curve: Acquisition multiples are based on historical earnings and as such does not take into account if you are growing rapidly, reached maturity or are in decline.
- Lack of verifiable underlying elements (EBITDA) distorts true comparison:
- State of Assets
- Capital Stress
- Possible synergies between the companies that could inflate the price to the acquiring company.
Think of it this way, you would never base the decision of what to pay for your new car based what your acquaintance paid. It doesn’t take into account the brand, model, year model, millage, last service of the car, recent replacement of engine or other parts. Without taking into account the very unique aspects of this car you will not be reaching the fair value on the sale, and someone is going to get shortchanged.
So how should you value your company in order to sell it? Short answer – (DCF) Discount Cash Flow method. Long answer – Coming soon!