Valuation multiples – adjusting market prices for your business valuation
Valuation multiples are commonplace in business valuations. Their appeal is that it is easy to estimate your business value by comparison to sales of similar companies.
Yet no two business enterprises are the same. How can you make sure that the valuation multiples you use give you the right answers about your company’s worth?
Focus on the way the business differs from companies used to calculate the valuation multiples. Then make the adjustments, as needed, to ensure that your market comparison holds water.
Unlike the stock market where millions of shares of large corporations trade daily, private business ownerships do not change hands that often. If you are valuing a privately owned business you may be able to find just a few comparable business sales.
Expanding the business sales data set
The more unique the business, the fewer business sales you have to compare against. If you can only locate a handful of transactions involving really comparable companies, you may decide to include additional business sales in your data set. While some of these firms may not be quite the match for your business, the larger number of data points helps to come up with a meaningful set of valuation multiples.
Adjusting business sale comparables for time
Another adjustment to consider is time of the comparable sales. If the market conditions changed relatively little over the last few years, the business selling prices may be usable without significant change. However, if the market underwent significant structural changes or economic slowdown, the current business selling prices may be falling. If you are gathering information on sales three to five years ago, your valuation multiples would need to be adjusted for this market trend.
Regulatory compliance, cash flow, and business value
New or changing regulatory compliance issues may call for another adjustment to your valuation multiples. Cost of such compliance may have quite an effect on business profitability. Since cash flow is the key measure on which to base your business valuation, any anticipated cost increase will affect the business value.
In your industry sector, many other important trends can affect what the business is worth. There are no hard and fast rules on this. Every business is different. How the company is affected by a particular development may differ as well.
Knowing what questions to ask, how to gather the relevant market comparable data, and make the adjustments to your valuation multiples will determine how accurate and useful your business valuation is.
See Valuation Tour