How Many Multiples of Revenue Is a Business Worth?

The worth of any particular business is an open question. We can only get closer to understanding it by looking at income, making projections, and gauging what that business might sell for on the market.

With NerdWallet reporting that 4.3 million new business applications were filed in 2020, and 32.5 million American small businesses in existence in 2021 according to Oberlo, it’s inevitable: a select few businesses are going to rise to the top, in terms of value.

Should you ever choose to sell a business you own, you’ll want to make the most money possible from the sale. If you’re looking to buy a business, you might be interested in making sure you don’t overpay, if a company is not worth its asking price. That’s where a solid, accurate valuation comes in for buyers and sellers.

Revenue can be an important number to look at when it comes to business valuations, but there are many potential pitfalls. A professional broker can help you determine whether revenue (as opposed to other aspects of business income) is the best number to use when valuing a business.

The Times-Revenue Method

Businesses are often valued using a “multiples approach,” where a dollar amount representing income is multiplied by certain whole numbers or fractions. A common multiples approach is known as the “times-revenue” method.

This method simply calls for multiplying the revenues of a business over a certain period of time (such as a year) by a specific number.

A venture that earns $1 million per year in revenue, for example, could have a multiple of 2 or 3 applied to it, resulting in a $2 or $3 million valuation. Another business might earn just $500,000 per year and earn a multiple of 0.5, yielding a valuation of $250,000. The multiples chosen are based on various factors unique to the business.

When using the times-revenue model, an analyst or broker may look at the business income numbers recorded in pro forma financial statements, which make projections within hypothetical scenarios, as the basis for the “revenue” part of the equation.

Pros And Cons Of The Times-Revenue Formula

The times-revenue method is a good way to establish a “ceiling,” or the highest possible price in theory, that the business can attract at a sale. It is fast and easy to calculate, without having to incorporate all the nuances and variables that influence value.

The times-revenue approach may also be important for estimating the value of companies with unstable monthly profits, but a high earning potential regardless. Businesses like these include early-stage technology startups that heavily reinvest revenues into growth or companies in fast-growing industries where profit margins are expected to be very high.

A pitfall of the times-revenue method, however, is that it focuses on revenue alone. Big-picture revenue often fails to represent a business’s value accurately and can hide cash flow or debt-handling problems.

Generally speaking, this is the hierarchy of business income, from larger and less reflective of value to smaller and more reflective of value:

Revenue > Gross Profit > EBITDA (Earnings before interest, taxes, depreciation, and amortization) > Net Earnings

Revenue indicates how much money a business brings in through sales. However, if a large portion of that income is going into overhead, maintaining operations, or is being wasted or spent inefficiently, net earnings might be relatively low.

In that case, applying a multiple to top-line revenue can easily overvalue an unhealthy business.

Factors That Influence Multiples And List Prices

Whether the times-revenue method or another valuation formula is used to value a business, multiples will come into play.

It is the multiple that addresses the “how many times income” part of a business valuation — whether income is defined as top-line revenue, EBITDA, or net income after taxes.

Factors that affect the multiples and ultimate list prices that brokers, analysts, and investors may determine include:

Industry Trends

Different industries are affected by economic shifts, consumer behavior, availability of raw materials, and more. Some of these trends are temporary, while others might last for a long time, dragging down the performance of businesses across the board in that market.

Businesses in troubled industries, or where profit margins are squeezed by any number of factors, might fetch lower multiples. On the other hand, in industries that are poised for growth and show healthy leading indicators, sellers might be able to argue for higher multiples.

Recurring Revenue Potential

Businesses that use or intend to use a recurring revenue model, such as monthly or annual recurring revenue (MRR or ARR), may position themselves to increase in value over time as they grow their customer base.

The recurring revenue model, which subscription-based services and many SaaS (software as a service) businesses use, comes with a lot of potential upsides and less risk to investors. As a result, these businesses often receive somewhat higher valuations.

Independence From The Owner

When a sole proprietor must handle all sales, fulfillment, and decision-making in a business, it can be risky. If the owner ever experiences illness or hardship, or for whatever reason cannot handle the demands of running the business, everything can collapse.

For this reason, businesses with multiple senior leaders, or an owner who’s reasonably distanced from daily operations, represent less risk to investors and may be valued with higher multiples.

Operational Efficiency

Does the business manage costs well, and minimize them wherever possible? Does it keep the lights on while resolving debts and staying on a path towards consistent positive cash flow, month-over-month, and quarter-over-quarter?

The answers will reveal how efficient a company’s operations are. Buyers are willing to pay more for businesses that run smoothly as a result of managing money smartly.

What Valuation Multiples Mean To Sellers And Buyers

To buyers and investors, valuation multiples are essentially numbers that represent the level of risk.

A buyer might invest more in businesses that can maintain high revenues over time while adapting to shifts in the market. That may be reflected in higher multiples.

On the other hand, businesses that may not maintain the same amount of income going forward, whether it’s due to internal performance factors or external market conditions, are more likely to be valued at lower multiples.

By reducing the risk to potential buyers an owner can sell their business for a higher multiple of their revenues or earnings, whichever is most relevant. One way to do this is to lengthen the due diligence process and implement strong marketing and sales strategies.

Asking The Right Questions

To answer the original question — How many times revenue is a business worth? — a typical business is often worth less than a whole-number multiple of pure revenue. In some cases, it can be worth more.

A definitive answer is hard to determine since revenue is so non-specific. The times-revenue method leaves open the chance of either overvaluing or undervaluing a business, depending on profit margins and other factors. However, there may be no better way to value certain kinds of businesses.

For quickly growing startups in a pre-earnings stage, the times-revenue method might be the most viable way to appraise the venture, and thus get close to the actual value, even though it leaves out a lot of details.

However, two better questions might be:

“What multiple of net earnings is a business worth?” This takes a realistic look at profits and likely future earnings, instead of just revenue. Businesses with sales performance that demonstrably increases over time represent less risk for a buyer. As a result, such ventures have a better chance of selling for higher multiples.

“What factors unique to a business will influence the fair market value?” This narrows down the price even more based on all owned assets, such as a customer base, contracts, a brand presence, vendor relationships, and more. It also considers the health and stability of operations, and whether a business is on the right path for growth.

Work With A Broker

Figuring out all the above can be arduous, but an experienced broker can help. The experts at Raincatcher have many years of experience working with business owners and investors of all types and know how to evaluate a company’s worth beyond the numbers and formulas.

Contact Raincatcher today for a confidential business valuation, whether you’re looking to buy or sell.

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