The Valuation Multiple
- Exiting a Business
- Increase Business Value
Businesses are generally valued using the Future Maintainable Earnings approach, whereby the maintainable profit (EBITDA, EBIT, NPBT or NPAT) is multiplied by the valuation multiple. This results in the enterprise value of the business and often includes the necessary Plant and Equipment, inventory and working capital required by the Purchaser to continue to carry on the business.
Understanding the factors that influence the valuation multiple provides a business owner with a unique chance to work on increasing the multiple so that they maximise the business value and the resulting sale proceeds.
The multiple is a reflection of risk. The higher the risk, the lower the multiple and the lower the business value. The table below illustrates a business which generates $500,000 in maintainable earnings and the effect of three different risk ratings:
The Multiple is calculated as the inverse of the risk rating (i.e., 1 divided by 50% = a multiple of 2.0). The risk rating represents the fact that an investor would require a 50% return on their investment due to the high-risk nature of the investment.
The less risky, the lower the return required by a Purchaser, the higher the multiple and the higher the business value. The above table shows the increase in business value if the risk reduces from 50% to 25% and 20%.
So it follows if a business owner is able to reduce the risk of their business, the incoming Purchaser will accept a lower rate of return and will be willing to pay a higher sale value for the business. We take this into consideration for each and every client that entrusts the sale of their business with us. Put the sale of your business in the right hands and contact us today.