Business valuation market method multipliers are useful as rules of thumb or sanity checks on business valuations, calculations, and estimates. Below, I include many small business multipliers and industry multipliers such as construction, HVAC, plumbing, auto repair, manufacturing, accounting and service businesses, liquor stores, distributors, and more.
Many business owners just want the question answered – what is the business valuation multiplier for my business? Well, hang on. Using multipliers for business valuation is at best a rule of thumb and not a professional business valuation. Although sometimes, a multiplier is all you need.
Disclaimer: These business valuation multipliers are our best belief based on 20+ years valuing hundreds of small businesses and brokering over 60. The typical small business has an SDE multiplier range of 1 to 3, and 2.2 is about average. Again, using these multipliers is a rule of thumb NOT a business valuation. Always obtain a professionally prepared business valuation for major life decisions, tax matters, estate and gift tax planning, succession and exit planning, required fairness opinion or other compliance.
Watch the 1:35 Minute Video About Market Multipliers and
Rules of Thumb Below.
What is a Business Valuation Multiplier?
The market method valuation approach formula for valuing business is:
Future Cash Flow x Multiplier = Indication of Value
Multipliers are estimated by taking reported business transactions and dividing the sales price by the business’s reported cash flow. This is the only method that ties to actual sales in the marketplace. In an actual business valuation, there are several other additions to the formula. These include adjusting the cash flows, adjusting the balance sheet, and taking into account discounts and premiums. All of these can impact value. Business valuation is more than this simple version of the market method formula.
There are several cash flows commonly used including revenues, Sellers Discretionary Earnings (SDE), and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) in the market method. There are other cash flows occasionally used or used in different industries including gross revenues, EBIT, after tax cash flow and more. I recently shared more about cash flows in “Five Cash Flows Used in Business Valuation.”
It is important to align the cash flow used with the proper multiplier. It is also important to adjust the multiplier based on profitability of the company, systems, employees and contractors, customers, products, inventory on hand, economic outlook, industry outlook, and many other factors. That is why just applying a multiplier to a cash flow without judgment can be so misleading.
How to Select the Right Multiplier
Most business owners select a multiplier that is too high. Certainly there are “high multiplier” companies out there, but often the cash flow multiplier actually drops as the company becomes more profitable. While this seems hard to believe, we have charted hundreds of companies and can assure you it is common.
When the market method is properly applied, multiple data points (usually 10 – 30) are obtained and compared to the subject company. Usually industry, revenue range, date range of transactions, and profitability range are all searched. It is important to chart the data by profitability. Comparables are then examined as a group. When appropriate, they are also examined individually to fully understand how the comparables really compare to the company being valued. We recommend DealStats from BVR as this is the best small business data at this time.
Multipliers Are Not Always Best in Business Valuation
As with all business valuation, professional judgment comes into play. While we are pleased to post these business valuation multiples for your use we highly recommend you have a proper business valuation performed by a professional business valuator–if it is to be used for anything beyond a fun conversation.
We are always available to serve you in that capacity. Contact Greg Caruso for more information about professional valuation services.
As I’ve written about previously, the three main valuation methods each have their pros and cons. Understanding valuation means understanding when to use the Income approach, the Market Methods approach, and the Asset approach. Here are some basics about these approaches, and when to use them.
A Profitable vs. Unprofitable Business Valuation
As much as business owners hate to admit it, there are unprofitable businesses. Remember, you can evaluate a unprofitable business. It just means taking a different approach. The Income and Market approaches are primarily used when valuing a profitable business. The Asset approach has methods that tend to be used for unprofitable or poorly performing businesses with significant assets.
The Income approach uses the Capitalization of Earnings Method and the Discounted Cash Flow Method.
The Market approach uses methods such as the Revenues Method, the SDE (Sellers Discretionary Earnings) Method, and the EBITDA (Earnings Before Interest, Taxes, Depreciation, Amortization) or EBIT (Earnings Before Interest and Taxes) Method. Each method is a different cash flow, and can be used for a comparison between the company that is being valued and a comparable company.
Small Businesses Can Benefit from the Income Approach
The Income approach is the most commonly used method for small business valuation, generally using the Capitalization of Earnings method. This is usually the best approach because of its simplicity and the fact that it can be applied to most businesses.
The Capitalization of Earnings method typically looks to the past 3 to 5 years of after-tax cash flow. This is used to estimate a cash flow for the future. This single cash flow figure is divided by a capitalization rate, commonly referred to as the Cap Rate. The capitalization rate is usually estimated using a Build Up method for the different risk levels from public market data made available by many sources including Business Valuation Resources (BVR) (https://www.bvresources.com/) and Duff & Phelps (https://dpcostofcapital.com/).
The Problem with the Income Methods for Small Businesses
The methods are not always perfect for small businesses. There is no quantifiable information linking small companies to public data–they don’t have to make their information public. This is less of a problem for larger small companies (those with EBITDA above $400,000), since there are several methods that appear to provide a reasonable starting point for analysis. These include the Duff & Phelps Navigator, using the Build Up in the Risk Premium Report Study section with the Regression Equation Method button turned on.
However, a smaller company may have insufficient cash flows for any other method than SDE to work. In this case, there is absolutely no data to estimate the Company Specific Premium. The Company Specific Premium is the adjustment used to bridge the gap between the public data and small company reality. There are no third party sources of Specific Company Premium for SDE cash flows. This means for smaller companies, the Cash Flow Market Method makes more sense. Fortunately, for these smaller companies there is usually more comparable market data making this method when properly applied quite supportable.
The Cash Flow Market Method for Small Businesses
Cash Flow Market Methods review the past to estimate a future cash flow. You select a comparison set of actual reported transactions from a transaction database. Then, this set is reviewed against the company being valued and a multiplier is selected. The multiplier is then multiplied against the cash flow to find the business value. I explain a very effective methodology for selecting and reviewing comparables in my book, The Art of Business Valuation, Accurately Valuing a Small Business, which you can purchase at this link.
There are legitimate issues and concerns around quality of the comparable data when using the Market Methods. Yet, with enough data points (which doesn’t have to be that many, depending on the data set) and analysis, you can reach a high-level supported comfort. For businesses with SDE under $500,000 and EBITDA under $400,000 the Market Method Cash Flow is usually the best way to value a business.
There are three business valuation approaches or methods:
The Asset Approaches are where the individual assets of the business are valued as if they were being sold.
The Market Approaches are where comparable market sales are used to estimate a value of the company.
The Income Approaches are where the risk to investors is compared to all investor investment choices to determine value.
More detail below:
The Asset Approaches are where the individual assets of the business are valued as if they were being sold. This is usually used for non-performing businesses that may be liquidated.
The Market Approaches are where comparable market sales are used to estimate a value of the company. The formula is the cash flow times the multiplier equals the value (or $100,000 cash flow x 2.2 multiplier = $220,000 value). The multiplier is developed by looking at the sales price of the comparable sales data usually obtained from reporting services and dividing it by the cash flow. (Multiplier = Price / Cash Flow or $100,000 price / $50,000 cash flow = a multiplier of 2.) For very small businesses these comparable businesses may be mainly owner operated businesses.
When reviewing the various market methods a major concern is the comparability of the selected comparable companies to the company being valued. Are they similar or very different? In addition the valuator needs to make reasonable adjustments for overall risk of the company being valued vs. the comparable set. For instance a company with two clients each at 50% is much more financially risky all things being equal than a company with 100 1% revenue clients. The multiplier should be adjusted to reflect company risk vs. the likely risk in the comparable set.
The Income Approaches are where the risk to investors is compared to all investor investment choices to determine value. Public market data is used to develop a discount rate. The discount rate is divided (along with present value adjustments) into a projected cash flow in the discounted cash flow income method. This is a quite complex formula. A more commonly used income method with small businesses is the capitalization of earnings method. In this method a capitalization rate which is a discount rate minus a growth rate is applied to historic earnings adjusted by the growth rate for the next year (selected historic cash flow of $100,000 and a 3% growth rate = $103,000 adjusted cash flow / .25 (a discount rate of .28 – .03 growth) = $412,000 value). Discount rates are generally developed for very small businesses using the build-up method (also called the BUM). In short, the cost of capital for different layers of business risk has been calculated looking primarily to public companies and public information.
Each layer of a build-up should be carefully reviewed to make sure it was developed correctly as of the proper valuation date. The last layer in the buildup method is specific company risk which is valuator judgement where all of the specific strengths and weaknesses of the business are accounted for that may impact Risk. Note that Risk for business valuators is the perceived likelihood that future cash flows will not be met.
In all cases there is tremendous judgment in estimating a multiplier, discount or capitalization rate. Which method to use depends on the facts in the case and the available data. For smaller and micro businesses (I define as usually under $10 M revenues) there often is quite a large amount of market data which should favor using that method. For businesses over $10 M in revenues there may not be enough relevant data to use the market method. Then the income method is likely to be the best method. Remember, methods are models and none are perfect. We must select the best method based on all factors. That, is professional judgment at work.
In all cases, use common sense. Make sure the selected value ties into the risk (and has some relationship to a price someone would pay) of the company including likely economic, industry, and other foreseeable changes in the future.
Greg Caruso, JD, CPA, CVA, the author of “The Art of Business Valuation, Accurately Valuing a Small Business” 2020 published by Wiley is always available to prepare (or review) business valuations for all purposes and situations.
Market Approaches in business valuation compare market sales to the company being valued. This is done by estimating a ratio of sales price to cash flow called a multiple or multiplier (i.e. $300 sales price / $100 of cash flow = a multiplier of 3.) Then the selected multiple is applied to the same estimated cash flow of the subject company to determine a value.
Thereafter the multiplier is multiplied against the subject company cash flow to obtain an estimate of value.
Business brokers often have “rules of thumb” that use the market method formula. For instance deli’s sell for 35% of revenues. This is not based on research and detailed thought, just a form of common knowledge. Technically, that does not reach the level of a valuation as it is unlikely to be supportable.
Two primary Market Methods are most frequently used by valuators are:
The Public Company Guideline Comparable Method which uses stock prices from similar public companies. This methodology is really not suitable for most small and very small business valuations as large companies tend to be quite different from small ones. Namely, is Home Depot like your corner hardware store?
The second method is the Private Company Guideline Comparable Method.
The Private Company Guideline Comparable Method uses transaction data from private company sale databases. DealStats, Bizcomps, and Valusource Market Comps are all good sources for small and very small business comparables.
Typically, the valuator will start the process to find comparables by searching for the industry by NAICS (North American Industry Classification System) or SIC (Standard Industrial Classification) system codes. Depending on the number of results (at least 8-10), the valuator may add related codes or narrow the search by company size based on revenues and perhaps profitability based on profits or a defined cash flow. Comparable data is then reviewed using key word sorts, detailed data, charting and graphing results based on cash flow profitability and other indicators to see how similar it is to the subject company. These reviews are very detailed and complex.
Finally, a multiplier is selected by reviewing the comparable data and the subject company for both financial information and soft data. (These resources can include both internal such as concentrations, management strength, systems, etc. and external such as the economy and industry).
This process requires both skill at analyzing the data and professional judgment. But, for small and very small businesses (also known as micro-businesses), the market method is the only method of business valuation that can really be tied into market data.
Typical cash flows used for valuation may include:
revenues
gross profit
EBITDA (earnings before interest, taxes, depreciation, and amortization)
SDE (seller’s discretionary earnings which is EBITDA plus all the ways one owner makes money from the business)
Each has advantages and disadvantages. The choice should be based on the fact pattern of the business and, of course, the available, selected comparable data. In general, in less experienced valuators hands, EBITDA or SDE tend to result in more useful values than the other possible cash flow choices. This is because people buy businesses based on the amount of money they think they will make in the future owning the business.
In many cases, a final adjustment needs to be made for assets or liabilities on the balance sheet beyond those typically conveyed for the price specified in the market data database.
An example of this is that in many retail businesses inventory purchased by the buyer is added to the value found based on cash flow.
The Market Method for providing an opinion of value of a business is often complex and relies heavily on experienced professional judgment. With a skilled valuator, the Market Method is the best method for valuing most small businesses with revenues below $5,000,000 and should be reviewed carefully for valuing companies with revenues up to $10,000,000 or more.
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