How can you determine the best multiple to use in deal valuation?

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When you are evaluating a potential deal in investment banking, one of the key steps is to compare the target company's value with similar companies in the same industry or sector. This is done by using multiples, which are ratios that measure how much investors are willing to pay for a certain aspect of a company's performance, such as earnings, sales, or assets. But how can you determine the best multiple to use in deal valuation? Here are some factors to consider.

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Consider industry benchmarks:

Look at the average multiples used within your target company's sector. This helps you align with market standards while considering unique aspects of the business.### *Ensure data reliability:Use recent and accurate data to calculate your multiples, ensuring it reflects current performance. This approach captures future potential and avoids distortions due to outdated or inconsistent information.

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Paras Doda

Investment Banking | Fundraising |…
Abhinav Goel

Equity Analyst - Value Research |…

1 Industry norms

Different industries have different characteristics that affect how investors value them. For example, a high-growth tech company may have a higher price-to-earnings (P/E) multiple than a mature utility company, because investors expect more future profits from the former. Therefore, you should look at the industry averages and ranges of the multiples that are commonly used for your target company's sector, and choose the one that best reflects its competitive position and growth prospects.

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Paras Doda

Investment Banking | Fundraising | Pitch Decks | Financial Modeling
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Industry multiples are a helpful starting point as they reflect market trends and compare a company's value to similar ones. However, relying solely on these multiples might not capture a company's unique strengths, growth potential, or market conditions, which can make a different multiple more appropriate for accurate valuation.

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Abhinav Goel

Equity Analyst - Value Research | SAC'24 (DU)
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Here are some common methods to determine the best multiple: 1. Comparable Company Analysis 2. Precedent Transaction Analysis 3. Discounted Cash Flow (DCF) Analysis 4. Use industry-specific benchmarks and guidelines to determine typical valuation multiples for companies in that industry. 5. Take into account the specific characteristics of the company being valued, such as its growth prospects, competitive position, and risk profile.

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Tuluhan Erdemi

Independent M&A Advisor | 12 years of experience | Identifying investors/ targets, valuation, due-diligence, integration, M&A process management services
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Using an overall sector multiple is not the best approach but could be helpful for comparison. It is always better to find relevant subsector multiples. For example, in life sciences, there would be different multiples for biotech, OTC, CMO and big pharma. Therefore, using a general life science multiple would not be the best approach while defining the firm value.

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2 Quality of data

The quality and availability of the data that you use to calculate the multiples also matters. You want to use the most recent and reliable data that reflects the current and expected performance of the target company and its peers. For example, if you are using the EBITDA (earnings before interest, taxes, depreciation, and amortization) multiple, you should make sure that the EBITDA figures are consistent and comparable across the companies, and that they exclude any one-off or non-recurring items that may distort the valuation. You should also use forward-looking data, such as analysts' estimates or projections, rather than historical data, to capture the future potential of the target company.

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Tuluhan Erdemi

Independent M&A Advisor | 12 years of experience | Identifying investors/ targets, valuation, due-diligence, integration, M&A process management services
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Not all multiples are based on the financial figures that are prepared in the same fashion. For example, for some deals you may see "adjusted EBITDA", while for the others only "unadjusted/ reported EBITDA" is used. The same applies for the revenue multiples. It could be gross or net revenue. This is actually one of the drawbacks when using the multiples analysis.

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3 Adjustments and assumptions

Sometimes, you may need to make adjustments or assumptions to the data or the multiples to account for differences or uncertainties between the target company and its peers. For example, if the target company has a different capital structure or tax rate than its peers, you may need to adjust the EBITDA multiple to reflect the impact of debt and taxes on its value. Or, if the target company has some unique assets or liabilities that are not reflected in its financial statements, such as patents or litigation, you may need to add or subtract their value from the multiple-based valuation. You should always explain and justify your adjustments and assumptions, and test their sensitivity to different scenarios.

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4 Multiple methods

Finally, you should not rely on a single multiple to value a target company, but use a range of multiples that capture different aspects of its performance and potential. For example, you can use the P/E multiple to measure the earnings power of the target company, the EV/EBITDA multiple to measure its cash flow generation, and the P/S (price-to-sales) multiple to measure its revenue growth. You can then compare the results of these multiples with each other, and with other valuation methods, such as discounted cash flow (DCF) or precedent transactions, to check for consistency and reasonableness. You can also use the weighted average of these multiples to derive a more balanced and robust valuation.

Using multiples is a common and useful way to value a target company in investment banking, but it is not a simple or straightforward process. You need to consider the industry norms, the quality of data, the adjustments and assumptions, and the multiple methods that are relevant and appropriate for your deal. By doing so, you can determine the best multiple to use in deal valuation, and present a compelling and credible case to your clients and stakeholders.

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Tuluhan Erdemi

Independent M&A Advisor | 12 years of experience | Identifying investors/ targets, valuation, due-diligence, integration, M&A process management services
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It is crucial to take into consideration the maturity of the business while choosing the multiples. For example, in the case of negative EBITDA businesses, it would be better to use revenue multiples. Or for consulting companies, you could look at EV/ Employees as well.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you determine the best multiple to use in deal valuation?

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1 Industry norms

2 Quality of data

3 Adjustments and assumptions

4 Multiple methods

5 Here’s what else to consider

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