What factors influence the business valuation multiplier?

Many of the common business valuation methods use multiples of earnings like EBITDA or P/E ratio to calculate the value of your business. These multiples, known as the “business valuation multipliers”, can significantly increase or decrease the ultimate value of your business. Let’s say your EBITDA is £1m. With the business valuation multiplier calculated to be x4, your business would be valued at £4m. However, if that multiplier was calculated to be x6, you could be landing an extra £2m i.e. 50% more for your business.

Given the impact a multiplier can have on the final business value, it’s vital for you as a business owner to fully understand the factors that can influence the calculation of the multiplier. This will enable you to better prepare your business for valuation and ensure that you get maximum value for your business.

While different factors influence the calculation of a multiplier depending on the type of business and the industry it operates in, it is essentially driven by the evaluation of perceived risk associated with your business. In this blog, we’ll discuss some of the key factors that influence the business valuation multiplier.

  1. Financial performance:

Some key indicators of financial performance that influence the calculation of a multiplier include; Does the business have healthy margins (gross/profitability)? How vulnerable is the cash flow? Is there a growth trend in business revenues for the last 3 years? How healthy is the future revenue pipeline?

  1. Market industry type and trends:

Businesses operating in a niche market segment with high growth are valued higher e.g. some SaaS or Fintech businesses. Similarly, a traditional business operating in a mature industry that is going through a digital disruption where the business is being challenged by changing market dynamics would have a negative influence on the multiplier.

  1. Owner dependence:

Greater dependence on the owner due to their specialist skills, industry network or sales capability increases the potential risks for a buyer and makes the business less attractive. This negatively influences the calculation of a multiplier. However, having strong management in place with a good governance structure mitigates that risk to the business and the valuation multiplier.

  1. Strength of the customer base:

A business that is disproportionately dependent on 1-2 customers that account for around 50% or more of the total revenue, is considered to be at a higher risk. Similarly, a business with a high turnover/churn rate of customers or subscribers negatively influences the valuation multiplier because it doesn’t guarantee long term stability and sustainability of the customer base.

  1. Goodwill and brand reputation:

Businesses with a good reputation, an established brand name and some level of goodwill/influence in the industry can have a positive influence on the calculation of the business valuation multiplier.

  1. Size of the business:

Larger sized businesses typically get higher multipliers, different studies have found. It’s mainly due to the perceived risk associated with a smaller business. Aspects like owner dependence, lack of industry influence and lower bargaining power of smaller sized business are to name a few. However, how much of an influence a business size can have on the calculation of a multiplier is dependent on the industry type and its trends.

  1. Age of the business:

Although age is considered when multipliers are calculated, there is no direct correlation. Older firms could have some positive influence as they are expected to have stability, brand recognition, customer loyalty, established systems & processes, etc. However, on the flip side, older businesses can also have legacy issues or baggage that can be considered a risk.

It is important to note that a single factor alone can’t significantly influence the calculation of the business valuation multiplier. However, all these factors combined and evaluated in the right context will influence the multiplier for your business.

Calculation of a multiplier is a complicated exercise in the business valuation process. As a business owner, it’s important that you understand which factors could influence the multiplier and ultimately the value of your business. Contact our experienced Business Advisors to help you better prepare your business for valuation so you can make your business worth selling. After all…

A Business Worth Selling Is A Business Worth Owning!