4.16: Multiples (and capitalization rates) – one size does not fit all

Business owners can be excused for feeling confused when they hear professional business valuators talk in terms of Capitalization Rates while business brokers and M&A advisers refer to Multiples. One major reason is that business valuators develop capitalization rates using a “build-up” method and consider a number of individual financial and risk related issues. Multiples, on the other hand, tend to be less finessed and are usually based on market comparables, i.e. what other businesses have sold for.

Capitalization rates, once developed, are easily converted to multiples as multiples are really just the inverse of capitalization rates. If the CBV has determined that a suitable capitalization rate is 25%, this could be readily expressed as a multiple of 4 (i.e. 1 ÷ 0.25).

Multiples thus tend to be easier to use than capitalization rates. It is easier to understand that, for example, a business is worth 4 times its free cashflow than that the value is free cashflow divided by a cap rate of 25%.

Multiples also have a wider application than cap rates when reviewing the valuation metrics of completed transactions. Research results showing aggregated transaction values for a specific industry group are usually expressed in terms of multiples, for example (fictional sample):

Median enterprise value / Revenue 0.45 X
Median enterprise value / EBITDA 4 X
Median enterprise value / Seller’s discretionary earnings 6 X

The most important issue to recognize however is that, in valuation reports prepared by CBVs, multiples, like cap rates, are developed specifically for the business being valued.

There are no standard multiples for use across the board, even within a single industry.

There are no standard multiples that are applicable to every business. Even within a single industry, there are usually many and significant differences between individual businesses, leading to different multiples being applicable. Such differences may be in the company’s management structure, location, history, visibility, the list goes on. What it comes down to is that just because your wife’s cousin sold her dry-cleaning business for 5X EBITDA doesn’t mean that your dry-cleaning business will command the same multiple.

For more on Capitalization rates, go to Cap rates

Contact MVI for assistance in understanding the importance of developing the right capitalization rate and multiples for use in determining the value of your business.