Why valuation multiples are more complicated than you may think

It may seem simple. Just research an average EBITDA multiple for the industry you operate in and multiply it by your company’s EBITDA. If it is that simple, what’s the point of paying for a 100+ page valuation report? The truth is, valuation multiples are useful tools for approximating a company’s value, but in order to properly use them, it’s necessary to evaluate the underlying companies/transactions from which those multiples are being derived. The key is to ensure that the nature of the companies/transactions underlying the multiple you are using are similar to your company and also to each other.

For example, when using past private company transactions, pulled from a reputable database, some items you should evaluate are:

  • Do the transactions involve companies engaged in the same or similar line of business as the company you are valuing? IRS Revenue Ruling 59-60 states “When a stock is closely held, is traded infrequently, or is traded in an erratic market, some other measure of value must be used. In many instances, the next best measure may be found in the prices at which the stocks of companies engaged in the same or a similar line of business are selling in a free and open market.”[1] The same holds true when utilizing past private company transactions to value a company.
  • When did the sales take place? The more time that has passed, the less meaningful the related multiples will be when applied to your company.
  • What type of company was purchased? The type of entity being purchased, for example, C corporation, S corporation, etc., has an impact on the price a buyer is willing to pay. That is why it’s important that the multiple you use is derived from the sale of companies that are the same type as yours.
  • Was the sale consummated as an asset sale or a stock sale? It’s important that the multiple you use is derived from transactions that were either all asset sales or all stock sales. Whether a sale is to be consummated as an asset sale or as a stock sale, affects the price at which the buyer and the seller are willing to transact. In addition, specific balance sheet items need to be added or subtracted from the calculated value of your company, depending on whether you use a multiple derived from asset sales or stock sales.
  • Were there non-compete agreements, earnouts, or other sales arrangements included in the sales from which you are deriving the multiple? It’s important to evaluate each sale to see if any portion of the sales price was attributable to non-compete agreements, earnouts, or other sales arrangements and adjust each transaction to remove the effect of these arrangements.

These are just a few of the adjustments and considerations that need to be taken into account when utilizing industry multiples. It is also important to evaluate the qualitative factors of your company and give consideration to the impact they have on its value. The myriad of nuances in applying an industry multiple to estimate your company’s value illustrate the importance of consulting with an experienced valuation expert when considering the value of your company. Contact your trusted Lurie advisor for assistance.

 

 

[1] Revenue Ruling 59-60.

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