Valuation multiples by industry

You have quite a few industry specific valuation multiples to choose from. So if you pick the right ones, you can do quick “apples to apples” comparisons  to figure out the value of a company in your sector.

Typical valuation multiples

You can nail a pretty accurate business value number by using several valuation multiples.  Why? Because each multiple lets you consider a different measure of the company’s financial performance. For example, here is our short list of the typical valuation multiples for private businesses:

• Enterprise value (EV) to gross revenues or net sales.
• EV to net income.
• Business value to EBIT and EBITDA.
• Value to seller’s discretionary cash flow (SDCF or SDE).
• Company value to total business assets or owner’s equity.

Do valuation multiples vary by industry?

Great question. Just how much do the valuation multiples vary by industry sector? Let’s take a closer look at this.

Business value is about risk and returns. Therefore, to measure business value, you need to estimate both its earning ability and risk.  Firstly, you size business risk by calculating the discount and capitalization rates.  Secondly, you can use these numbers to run any income-based valuation method you want.

Valuation multiples work similarly. Just take a closer look at the multiples based on the EBITDA or net income. In fact, these valuation multiples act pretty much as the inverse of the company’s capitalization rate.  In other words, instead of dividing the business earnings by the cap rate, you multiply it by the valuation multiple. Either way, you calculate your business value.

Industry risk premium and valuation multiples

Now take a look at the Build-Up cost of capital model used to calculate the discount and cap rates. See the industry risk premium there? You guessed it, this additional risk is industry sector specific. And it works its way into the multiples you use.

Businesses in high risk industries are less valuable

The higher the industry risk premium, the lower the valuation multiple. So for a given level of earnings, the business has a lower value. Put another way, the businesses in a high risk industry are more risky and, therefore, worth less.

How to choose the best valuation multiple

With all these valuation multiples lying around, the question is: which one is the best? The best multiple is, of course, the one that gives you the most accurate business market value.

Let’s go back a step here. Now all these valuation multiples come from recent business sales in your industry sector. Moreover, each business sale gives you useful numbers such as the selling price, and the company’s financials.

Once you put enough sales data together, you can calculate all kinds of valuation multiples.  And then use them to estimate your business value. But some multiples are better than others.

For instance, it could happen that in your industry sector one valuation multiple,  say price to EBITDA, shows a ‘skinny’ bell curve with business values clustering tightly around the average. On the other hand, the price to gross revenue multiple could generate value estimates all over the map.

Which multiple best predicts your business value?

What does it mean? Market players in your industry tend to rely more heavily on one multiple when pricing  business sales. For example, most people value professional practices on gross revenues. That’s because practice owners often have different opinions about what goes into their EBITDA or Net Income.

The tool to pick the best multiple in your industry

Business appraisers use a secret weapon to estimate the spread of valuation multiples. They call it the coefficient of variation, equal to the ratio of the multiple’s standard deviation divided by its average. For a given multiple, the smaller the coefficient of variation, the tighter the spread of business selling prices. As a result, you can get a better handle on your company’s value.

This suggests a way to pick the best valuation multiple:

• First, gather enough data on recent business sales in your industry.
• Next, calculate a number of valuation multiples from this data using the actual business sale prices related to the companies’ financials.
• After that, calculate the coefficient of variation for each multiple.
• Finally, choose the multiple with the smallest coefficient of variation.

Valuation multiples by industry – some examples

Just how much do valuation multiples vary by industry? As an example, we’ll use the typical price to EBITDA multiples for several industry sectors to demonstrate the difference:

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