Business value: this is how you apply multiples

Do you have a company in mind to take over? Now, determining the business value is one of the most important steps. A correct valuation analysis prevents you from placing too high a bid. It also identifies financial risks. By making use of multiples, you quickly make the estimated market value of the company transparent. In our blog ‘Business value: this is how you apply multiples’ we will show you how you can apply them.

What are multiples
Multiples are used to map the business value of a company by comparing it with similar companies in the industry. These multiples are derived from financial models that use cash flows and the cost of capital. These market-based valuations are determined based on financial ratios and other relevant drivers. Every industry is different. Therefore, they have their own industry-specific drivers. It is important to realize that these are rules of thumb that must be applied with knowledge.

Multiples are rules of thumb
Multiples are referred to as rules of thumb. They therefore offer the possibility to determine the business value within branches. These can be the following formulas:

  • Firstly, a percentage of the annual turnover
  • Secondly, a factor times the result after tax
  • Thirdly, a factor times EBITDA.

EBIT stands for Earnings Before Interest and Taxes. The result is measured with the revenue and the costs that were needed to achieve this revenue. For example the cost of personnel and purchasing. Taxes, interest payments or interest income are not included.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. Profit before deduction of interest costs, taxes, depreciation and write-offs. EBITDA is often used especially for companies that are growing fast and that have a large debt due to takeovers. The reason for this is that the result after taxation for these companies is too negative.

Pitfalls of multiples
Although with a multiples valuation you can quickly give an indication of the value of a company, in practice it is not as easy as it seems. The three most important pitfalls can be found below:

  • First of all, a good group of comparable companies must be chosen. It is precisely this comparability that is difficult in practice. This is because companies often differ not only in product range, but also in the target groups on which they focus.
  • There is another pitfall for transaction multiples. Prices for mergers and acquisitions have not always been achieved rationally. To figure this out, you need a large number of comparable transactions.
  • For a starting company, the future value is highly dependent on the management team. In addition, shares cannot be traded as easily as with a listed company. That is why you must also apply a correction factor to the outcome.

We hope our blog ‘Business value: this is how you apply multiples’ gave you some directions. Are you curious about what to look for in addition to determining the business value when taking over a company? Read the tips in this blog.