Archive for April, 2011

Business Valuation Multiples

Wednesday, April 6th, 2011

Many, if not most, business valuation methods rely to a degree on multiples of earnings.  That is, annual earnings of the business being valued, are multiplied by a number to arrive at its estimated value.  What’s the number?  Well, arriving at the multiple for a particular business involves a mix of experience, data, and art.  Factors such as size, competition, longevity, industry, and even location impact on the multiple for which a business will sell.

Stock in venerable public companies often sell for Price Earnings rations (essentially multiples) of 15-18.  Stock in fast growing companies public companies sell for even higher multiples.

Sometimes owners of privately held small companies reason that their company will sell for multiples in those ranges.  However, they’re disappointed learn that is not the case.  Small privately held companies tend to sell for multiples ranging from about 2.5 to as much as 6.  There certainly are exceptions, but this is the typical range.  You see, small companies are inherently risky and buyers (investors) demand a premium for that risk.  What’s more, you can buy pretty much an amount of stock you want in a publicly traded company, and sell all or some of that stock at any time you wish.  In buying a privately held company you don’t have that kind of flexibility or liquidity and investors demand a premium for that liquidity as well.