Multiples have been increasingly used in recent years for indicative business valuation. The method is quick, simple and quite accurate. But it is a snapshot, which is less suitable for start-ups and high-growth businesses.
There are many methods to arrive at a business valuation. And each method has its advantages and disadvantages. Following the example of listed businesses - where this method has been used for much longer - valuation based on multiples has gained considerable ground in recent years. The multiple is a number usually expressed as "factor x gross profit" or "factor x revenue.
In SMEs, the multiple method primarily looks at transaction multiples, which are based on the recent transaction prices of comparable businesses. The main advantage of using multiples is that the method gives a quick and quite accurate indication of the current value of a business.
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This gives a picture of what is currently paid for similar businesses in the relevant industry and is a starting point for price negotiations.
Pitfalls
While a valuation based on multiples gives a quick indication of the value of a business, there are also some pitfalls. Because transaction multiples reflect the current value of a business, they are less suitable for businesses with large financial fluctuations such as start-ups, loss-making businesses or businesses with a steep growth curve.
For a start-up with a lot of potential or a growth company with solid future projections, a valuation based on current transaction prices would not give a realistic picture because a large part of the value is embedded in the future.
Another problem with valuing based on multiples is finding a good peer group of comparable companies. These are often businesses in the same industry with similar levels of gross profit or EBITDA. But in addition, other factors play a role in the final sales price, making a comparison sometimes difficult. Consider the region where the business is located or any synergy opportunities for the buyer.
In addition, in practice, a number of corrections are often applied to the multiples obtained. The same Brookz Takeover Barometer shows that smaller SMEs often have a lower multiple than larger SMEs. This has to do with dependence on management or a few large customers. Such a correction can sometimes be as much as 20 percent of the original multiple.
Cross-check
In the end, valuation is not an exact science. In practice, it is therefore wise to use several methods side by side. Multiples provide a quick initial indication in this regard and are often a cross check used for the more fundamental Discounted Cash Flow (DCF) method, which primarily looks at future cash flows.
This combination between the wisdom of the market (multiples) and understanding the value of a business (DCF) avoids vulgar horse-trading and at least leads to meaningful discussion about the true value of a business.
