What is the Earnings Multiple I Should Use For My Business?

This is probably the question that we get asked the most by business owners. Unfortunately, the best answer to this question is probably: ‘it depends…..’. Many people think that valuators have a ‘black book’ or database where they can simply look up the appropriate multiple for a given industry or type of business. However, most businesses are very unique and even within the same industry and geographic region may operate under different factors that significantly influence the value of the business. Ultimately, the earnings multiple is a reflection of the risks associated with the ability of a business to achieve an expected level of cash flows in the future. Some of the factors that influence the risk present in a business and consequently the appropriate multiple include:

  • general economic conditions and the state of the current business cycle;
  • relative returns available on other investments;
  • expected gross margin and profit margin;
  • the historical consistency of the company’s results;
  • the extent to which capital is required to operate the business;
  • the level of tangible assets within a business;
  • barriers to entry within an industry;
  • the relative size and strength of competitors; and,
  • the level of customer or supplier dependence within a business.

Unlike the real estate market, where data on comparable transactions of similar properties is readily available, information regarding purchases and sales of privately-held businesses is rarely available in the public domain, and the information that may be publicly available can often be misleading or incomplete. Determining the appropriate earnings multiple for a given business requires a valuator to consider all of a company’s internal and external risk factors and, based upon past experience, estimate the earnings multiple that they believe would be applied in the context of a notional sale of the business.