Valuation method
Multiples of earnings
The multiple method takes a normalised earnings figure and applies a factor drawn from comparable transactions. It is the most used method in this market, and the most often misapplied.
Which earnings figure
The multiple is meaningless without naming the base. Three are common. EBITDA, which ignores financing and depreciation. Operating profit, which does not. And seller's discretionary earnings, which adds back a single owner's remuneration and personal costs, and is used for owner-operated businesses.
A multiple quoted on one base and applied to another produces a number that is wrong by a wide margin. Comparisons between transactions are only useful when the base is identical.
What moves the factor
- Size: larger earnings attract a wider group of buyers and a higher factor
- Stability: a flat three-year record is worth more than a spike
- Dependence on the owner: the less, the higher
- Concentration: one supplier or one channel carrying the business pulls the factor down
- Growth that can be explained and repeated, rather than growth from one lucky season
- Transferability: accounts, contracts and rankings that survive a change of owner
The limits
A multiple assumes the future resembles the past. Where a business is in transition, where a channel has just changed the rules, or where results depend on a contract about to expire, the method describes history rather than value.
It also compresses everything into one number, which makes it a poor tool for negotiating individual terms. It sets a level; the terms are argued separately.
- Definitions of the profit figures used in valuations (https://www.businessforsale.eu/knowledge-base/profit-definitions)
- Seller's discretionary earnings explained (https://www.businessforsale.eu/knowledge-base/sellers-discretionary-earnings-sde-en)