A multiple, or multiplier, is applied to the cash flow (in our case, EBITDA) of a business to determine its value. The multiple is a way of measuring a buyer’s level of risk. The higher the multiple, the lower the perceived level of risk. That’s why large “Dow Jones” businesses sell for much higher multiples than a small business. There is less risk, so the buyer is willing to settle for a lower return on investment (ROI).
For example, if the sale price of a business was $4 million and the cash flow was $1 million, it would take four years to get the investment back. In other words, the buyer’s annual ROI would be 25%, and the multiple would be four times cash flow.
GENERAL GUIDELINES FOR MULTIPLES
The following model can provide you with some general guidance on business multiples. It shows that businesses trade at different multiples depending on the size of the business and the risks in a particular industry.
Adjusting the Multiple
The “art” of business valuation is determining where in the broad range of multiples your business sits. For example, if you have a well-established business, the above chart indicates the multiple could be anywhere from 3 to 4 times cash flow.
The answer lies in examining the characteristics of your business, both positive and negative—your key value drivers and qualitative factors. Once all those characteristics have been evaluated, a more precise multiple can be determined.