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.
How can you tell if a business valuation is correct or if it is likely to be biased, wrong, or outright rigged?
In the majority of business valuations, the business valuator follows accepted standards and delivers a supportable and unbiased valuation.
Unfortunately, a few business valuations are incorrect or inappropriate. Often this result is more because of inexperience or unrecognized bias rather than outright intention.
The wrong standard of value. Standards of value are standardized assumptions around who are the agreed upon buyers, sellers, timing, and other details of a sale. The wrong standard of value will subtly change many things in the valuation and often lead to an improper value.
The wrong valuation date. The valuation date is the cut-off date that the valuation is done through. For some valuation purposes the valuation date is critical. For instance, consider the value of a restaurant serving a tourist destination on a far-off island the month before Covid-19 shut downs and the month after. For some purposes the valuation date moves. This is common in divorce. The wrong valuation date can result in a wrong value.
The cash flow being applied against the wrong multiplier or discount rate. For instance a SDE (Sellers Discretionary Earnings) cash flow being applied to an EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) multiplier; a non-tax adjusted cash flow being applied to a standard tax adjusted build-up. This can greatly skew value and is not always as obvious to spot as it sounds.
Too Good To Be True, almost miraculously better or worse current year (or previous year) results than earlier periods. In some industries, many aspects of the accounting statements are based on allocations that can be tinkered with. Are gross margins consistent, were all expenses entered, are the period cut-offs correct? Does the economy, industry, company factors and more support the numbers? There may be a very good reason for the change in results, but make sure the situation makes sense.
Suspicious add-backs, one-time events, and so on. Adjusting entries to create “apples to apples” financial statements for comparisons to market data or discount rate data is essential. It is also a major area for error and trouble. Make sure comparability, one time, and discretionary adjustments meet the definition for the cash flow being used and are properly supported.
Cash flow weighting that is not supported by facts. Both the market method and the capitalization of earnings method weight historic cash flows to estimate a future cash flow value. This weighting should be done to tie into expected future results as reasonably influenced by the past and future expectations. Intervening events can make historic cash flows susceptible. This calculation is easy to miss and can greatly swing results.
Hockey stick projections. Similar to miraculously better financials are projections into the future. Companies that claim they are going to “take-off” next year. Certainly that could happen but support should be very strong and the discount rate should be higher to justify a value found.
Unusual or doubtful discounts, capitalization rates, and market data multipliers. These are all adjustments to reflect the risk of making or not making the required cash flow return into the future. The comparison set needs to be reasonably tied into the situation with the subject company. While the discount rate or multiplier is a simple number, estimating it requires experience and professional judgement.
A final value after all adjustments and balance sheet adjustments that is above a 100% financed business at 8%. This is extreme, but it happens, most often with very high inventory or receivables businesses. Again, the finance method is a great sanity check. In the Finance Method rule of thumb, you work back from the cash flow to estimate the loan principal amount it will support.
Cash Leakage. At the other extreme, a long-term high revenue business in a “cash” industry with very low gross margins and no value. While it could be a huge discounter, it may also indicate cash leakage and requires additional review.
Cherry picking. Namely, almost every choice was favorable to very favorable for a higher or lower value. Consistent but unjustifiable small gains or losses at every turn can greatly change the value found.
All of these issues, other than the first two issues, could be explainable and even correct. But, if these factors are present, look hard and ask questions before signing that the value found and the report is correct.
Conclusion:
If you are reviewing a business valuation you should make sure it is correct. The book, “The Art of Business Valuation, Accurately Valuing a Small Business” has 400 pages covering many professional judgement, calculation, standards, and other important valuation issues along with access to sample reports, calculators, and checklists downloadable from the web. This will be the one book you will reach for if you value or rely on valuations of micro or small businesses with revenues under $10 million. The book published by Wiley is available at your preferred bookseller. More information can be found at www.theartofbusinessvaluation.com
Finally Greg Caruso, JD, CPA, CVA, the author is always available to prepare (or review) business valuations for all purposes and situations.
JOIN our email list to stay current on changes in small business valuation, including how to address changing business valuations because of COVID-19.
