What is A Valuation Multiple and How Do They Work?

A valuation multiple is a mechanism used in business transactions to assign a value to a business.

What Number Is the Valuation Multiple Applied To?

1. Adjusted EBITDA

In 80% of lower middle-market business transaction, the valuation multiple is applied to trailing-twelve months adjusted EBITDA. This means, your profit for the past 12 months with any discretionary and non-recurring expenses added back in.

Using a weighted average of the past 2-3 years adjusted EBITDA and applying the multiple to that is also a somewhat common valuation methodology.

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Add-backs are a full discussion in and of themselves. We put an article together to give you a head start in understanding how profit adjustments work. EBITDA Add-backs.

2. Revenue

Revenue multiples become more common when the business has one or more of the below attributes:

  • Recurring Revenue

This can be contractually recurrings. Or, if your product or service is integral to your clients lives/businessses and you have a very low churn, the recurring nature does not have to be contractual.

  • High Growth

If your company has a high rate of growth, chances are that you are reinvesting into that growth (growth capital expenditures / CapEx). Therefore, money that would hit the bottom line as profit is being reinvested back into the company. Because of this, it makes more sense to value the company on top-line revenue.

An example of a business that can check both of these boxes is a SaaS company.

Many SaaS companies have sticky, recurring customers and have high growth CapEx due to their high marketing costs, need to reinvest capital into their sales teams and into developers to add new features. It isn’t uncommon to see growing companies with $10m+ in revenue not make any money to the bottom line. In these cases, the business gets a revenue multiple.

What Multiple Is Appropriate for Your Company

Determining the appropriate valuation multiple for companies in various industries is a nuanced process that we at Raincatcher take great care in.

In addition to the industry you’re in, the size of your company, market that you work in, market trends, and financial performance will all play a large factor in your multiple.

Ultimately, your m&a advisor should be able to give you a fair amount of insight on the valuation multiple and deal structure that you should expect in a transaction. However, understand that the best valuation multiples are achieved by running a full-scale auction process and getting multiple bidders to that table.

You can get started on finding our what your company is worth by requesting a consult with us. Or, by visiting our business valuation calculator page where we’ll gather some information on your business and get back to you with our thoughts on valuation multiples and how to best approach the market.

Other Business Valuation Methodologies

Companies with revenue and those with multiples are valued on a multiple of those metrics most often. However, there are a small handful of companies that are valued using other methodologies.

Pre-revenue Tech Companies

Valuing pre-revenue tech companies involves a unique set of considerations given their early-stage nature.  Valuation for these businesses relies heavily on factors such as the strength of the technology or intellectual property, market potential, the expertise of the team, and the progress made toward product development and market entry.

Venture Capital Investors and analysts may also assess the scalability of the technology and its potential for disruption within the industry, as well as the company’s ability to attract further funding or strategic partnerships. Oftentimes valuations will be on a multiple of daily or weekly active users (DAUs or WAUs).

Moreover, pre-revenue tech companies often undergo valuation through comparable analysis, where similar companies in the industry or with analogous technologies are used as benchmarks.

Asset Heavy Companies

Some companies such as foundries, mining and aggregate companies and transportation companies typically have very low cash flow in comparison to their asset value.

Because a multiple of their cash flow would typically equate to a lower total valuation than just the assets they own, they will oftentimes lease the assets to the new owner for an extended period of time after the business is sold. Alternatively, they could accept a long-term seller note or other deal structure.