Technique for valuing a company using the multiples method

When raising funds, looking for financing or selling a business, you need to determine its market value. This is often referred to as business valuation.

To determine the value of a company, experts use various methods depending on the size of the company, its sector of activity, its assets, the cycles of its activity, etc.

Among all the existing valuation techniques for theestimation of a company and its valuation, three methods are commonly used and in particular the multiples method. How to use the multiples method for a company valuation?

Definition of the multiples method to value a company

The multiples method can be summarized as the comparison of the company to be valued with other similar companies whose value is already known.

To apply it, we use the MIS (intermediate management balances) of the balance sheet of the company to be valued. It is then sufficient to carry out a rule of three in order to determine the value of the company compared to the competition.

In spite of its approach, which may seem very simple to implement, the multiples method requires an in-depth study of the accounting of the company to be valued in order to correct the data used and to make a fair valuation of the company.

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    The different steps for a valuation company

    The multiples method consists of two basic steps.

    • The first is to identify similar companies to form a panel (size, organization, geographic sector, etc.). The companies to be selected must be listed on the stock market or must have recently been sold in the sector of the target to be evaluated.
    • The second step is to use the multiples analyzed on the selected panel to calculate the value of the company through a simple rule of three. Thus, we determine an estimate of the company's value.

    We understand better the usefulness of calling upon a XVAL.FR expert in each sector who will be able to specify the "multiples" in force on the market of the company to be evaluated and to quickly propose you a coherent panel of companies.

    The various existing valuation multiples

    For a fairly accurate business valuation, a variety of multiples are generally used. These can be used individually or in combination.

    Value by multiple of sales

    While this multiple is quick to identify, it is the least relevant in terms of company valuation, as it does not allow for an analysis of the company's profitability.

    Valuation by the gross operating surplus (GOI) multiple

    The EBITDA multiple is the indicator most used by professionals because it is more complete than the turnover indicator. Indeed, its determination includes many items that will determine the profitability of a company: the turnover, the personnel costs and the operating expenses.

    To be relevant, this analysis requires many treatments: https: //xval.fr/valorisation-de-societe-pourquoi-lebitda-doit-etre-retraite-et-normalise/

    The multiple of the operating result

    It is used to fill in the gaps in the EBITDA indicator (profitability indicator) in terms of taking into account investments and depreciation of the company's assets.

    The REX or operating result takes into account the investment process with the calculated expenses (depreciation and provisions)

    This new data adds more precision in the valuation of a company, especially for companies requiring a strong capital investment: industry, R&D, etc.

    Net income multiple (PER)

    For a valuation of a listed company, the PER indicator is usually used. It is suitable for a company valuation based on the net results by potential investors. Indeed, this result makes it possible to take into account the management of the dividends of the company and its tax data, in short the potential return on investment for a stock exchange investor.

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      Which company to choose in order to apply the multiples valuation technique?  

      The most important challenge of the multiples valuation technique is to identify a company or group of companies similar to yours.    

      For example, if you want to value a truly disruptive start-up, you are likely to find no direct competitors, making this valuation technique unsuitable.    

      If you want to sell a more traditional business, you can use the multiples method, but you still need to find a company that is very similar to yours, i.e.: operating in a certain economic sector, providing a particular skill, operating in a similar geographical area, etc.   

      Each company is unique and there are elements that are difficult to compare: the personality of the leader for example, or the cohesion of the team.

      Any comparison is imperfect and the best thing to do is to look for companies operating in similar economic sectors or trades whose transfer price is known with certainty: wholesaler, manufacturer, service provider, retailer, etc.   

      The multiples method is not limited to a single comparison but to several (with different companies).

      Finally, the date of the transaction is another very important element: if the transaction took place several years ago, the transfer price is of limited use to you... Indeed, all sectors evolve from year to year, which can make the figures obsolete quite quickly.   

      To be contacted by a XVAL consultant for a valuation: https://xval.fr/  

      Is there a simplified multiple valuation technique?

      Yes: a company can be valued using EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and a standard multiple for the sector of activity.

      For example, let's say that our company X has a EBITDA of 1 million euros and that the median multiple observed in this sector of activity is equivalent to 5 x EBITDA. We can therefore make a very simple calculation for company X:   

      5 x 1 M € = 5 M   

      Then, we have to take into account the company's cash flow and debts. If our company X has a cash flow of 1 million euros but 2 million euros of debts, we make the following calculation:   

      5 M € + 1 M € - 2 M € = 4 M €   

      According to this (very simplified) multiples technique, company X is therefore worth 4 million euros.

      This method can give you a quick idea of the value of your company, but it is no substitute for expert advice...

      Is there a more accurate multiple valuation technique? 

      More precise results can be obtained by using the comparison and the elements mentioned above: sales, EBITDA, operating income (REX) and net income (NI).

      Let's say you want to compare your company Z to a company Y that had an initial value (EV) of €3 million, but had a debt of €1 million.

      The sale was therefore made for 2 million euros (equity).

      This company Y has:
      -a turnover of €8 million;
      -an EBITDA of €800,000;
      -an REX of €600,000;
      -an RN of €500,000.   

      With these data, we will calculate the proportion of each element in relation to the transfer value (the multiples).   

      The multiple of the turnover: VE / CA = 3 M / 8 M = 0,375
      -The multiple of the EBE: VE / EBE = 3 M / 800 000 = 3,75
      -The multiple of the REX: VE / REX = 3 M / 600 000 = 5
      -The multiple of the RN: equity / RN = 2 M / 500 000 = 4   

      With this data, we can now make a comparison with your Company Z. Your Company Z has the following data:   

      -a turnover of 10 M €;
      -a EBITDA of 600 000 €;
      -a REX of 500 000 €;
      -a RN of 400 000 €.   

      We now apply the coefficients obtained by studying company Y to your company Z :   

      10 M € x 0,375 = 3,75 M €
      -EBE of 600 000 € x 3,75 = 2,25 M €
      -REX of 500 000 € x 5 = 2,5 M €
      -RN of 400 000 € x 4 = 1,6 M €   

      For a traditional industry, the EBITDA multiple is the reference value. We will therefore traditionally retain a valuation of €2.25 million for your company Z.   

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        Is the comparison to a single company sufficient for the multiples method?   

        We then apply these average coefficients to the sales, EBITDA and net income of our company Z.

        The resulting figures will be much more reliable.

        Traditionally, the estimate made from the EBITDA takes precedence over the others, however, the other results can be used as a negotiation argument in order to possibly revise the transfer price upwards.   

        To summarize the valuation of a company by multiples

        In summary, the multiples method is not limited to simple calculations via the application of a ratio heard at the last trade show or shared by a colleague at the café. Several factors must be taken into account (accounting restatement, realization of the right panel, etc.) in order to have an accurate valuation of the company consistent with current market practices.

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