Multiplier Method

Multiplier Method: Business Valuation Made Easy?

How much is my company worth? Many entrepreneurs ask themselves this question, whether for a planned sale, a financing round, or simply out of curiosity. One way to quickly and easily estimate the value is the multiplier method. But beware: as simple as the concept sounds, there are some pitfalls to consider.

The Principle of the Multiplier Method

The idea behind the multiplier method is straightforward: you look at the prices at which comparable companies have been sold and derive the value of your own company from that.

Let’s assume that several companies in your industry were recently sold at eight times their EBITDA (earnings before interest, taxes, depreciation, and amortization). If your company generates an EBITDA of 1 million euros, then, according to this logic, it would be worth 8 million euros.

Mathematically expressed:

$Company\ Value = Multiplier \times Operating\ Metric$

In our example, the multiplier would be 8 and the operating metric the EBITDA of 1 million euros.

What Multipliers Are There?

There are a variety of multipliers that can be used for business valuation. Here are some of the most common:

• EBITDA Multiple: Company value / EBITDA
• EBIT Multiple: Company value / EBIT (earnings before interest and taxes)
• Revenue Multiple: Company value / Revenue
• P/E Ratio (Price-to-Earnings Ratio): Stock price / Earnings per share

Which multiplier is appropriate depends on the industry and the characteristics of the company. In some sectors, EBITDA is the relevant metric; in others, revenue is more significant.

Advantages of the Multiplier Method

The major advantage of the multiplier method is its simplicity. With just a few pieces of information, you can quickly create an initial estimate of the company’s value.

Additionally, the method is based on real market data. The multipliers reflect what buyers have actually been willing to pay for comparable companies in the past.

Last but not least, the multiplier method can help verify the plausibility of other valuation methods. If the value deviates significantly from what the multiplier method suggests, it’s worth questioning the reasons behind this.

Limitations and Risks

As tempting as the multiplier method’s simplicity is, it has its limitations and risks.

The biggest challenge: it’s not easy to find truly comparable companies. Every company is unique in terms of size, growth, risk profile, and many other factors. A multiplier appropriate for one company may be completely unsuitable for another.

Moreover, multipliers are always backward-looking. They are based on historical transactions and say nothing about a company’s future prospects.

Finally, the multiplier method is susceptible to manipulation. Through savvy accounting, metrics like EBITDA can be adjusted to inflate the company’s value.