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What are the most common exit multiples valuation methods?

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When you invest in a private equity fund, you want to know how much return you can expect when the fund sells its portfolio companies. One way to estimate this is by using exit multiples valuation methods, which compare the expected selling price of a company to a financial metric, such as revenue, earnings, or cash flow. In this article, you will learn about the most common exit multiples valuation methods and how they are used in private equity.

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Siddharth Kosaraju

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1 Enterprise value to revenue

This method calculates the ratio of the enterprise value (EV) of a company to its revenue. EV is the sum of the market value of equity and debt, minus cash and equivalents. This method is often used for companies that are not profitable or have high growth potential, as it does not account for costs or margins. The exit multiple is based on the average or median EV/revenue ratio of comparable companies in the same industry or sector.

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Siddharth Kosaraju

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I believe this is more apt for valuing businesses which are high-growth mode and whose Account/Customer- LifeTime is high. This often assumes the business in general has high retention for revenue. This is often used in industries such as SaaS owing to higher acquisition costs in growth phase, which puts profitability under stress. Thus, revenue is used as good proxy to stable/mature state profits.

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Sanjay H

Consulting Chief Financial Officer | 23+ Years in Strategic Leadership | Corporate Financing I Advisory I
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This method is very easy to calculate and understand as well as useful to early stage startup valuation . However there are some red flags too 1. It does not consider the profitability aspect at all. Companies with negative NP ratio will also get good valuation in this . 2. Inclusion of debt in EV is risky. Highly leveraged company will get high valuation at the same time its more important to see how they deployed the funds . In my opinion this shall not be used in isolation . This can be one of the method while making the valuation specially early stages

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2 Enterprise value to EBITDA

This method calculates the ratio of the EV of a company to its earnings before interest, taxes, depreciation, and amortization (EBITDA). EBITDA is a measure of operating profitability that excludes non-cash and non-operating expenses. This method is widely used for companies that have positive and stable cash flows, as it reflects their ability to service debt and generate returns. The exit multiple is based on the average or median EV/EBITDA ratio of comparable companies in the same industry or sector.

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Siddharth Kosaraju

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EV/Ebidta is a good valuation method to use for companies which are stable/mature state and where the profitability of the business is important factor. M&A industry uses this as metric to value firms, by using this ratio from the comparable firm in a similar industry. This is in general used when there is more maturity in the business which can help model the costs better for the stable state.

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Sanjay H

Consulting Chief Financial Officer | 23+ Years in Strategic Leadership | Corporate Financing I Advisory I
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This method is vary useful while making share valuation in MnA transactions as the target companies performance can be valuated by the acquirer by evaluation of the synergies and consequent cost saving measures. However the depreciation and interest are also very important expenses to arrive the correct profitability . Ignoring completely will not be good

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Sarath Nair

Executive MSc Finance and Technology | Strategy Analyst
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I like to use EV/EBITDA multiple to arrive at the Enterprise value at exit, and then proceed to understand the cash flow to equityholders. We can look at Transaction multiples and/or trading multiples of peer companies to arrive at the right multiple value to be used. In conjunction with the DCF method, I have been able to arrive at good equity valuations of target companies.

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3 Enterprise value to EBIT

This method calculates the ratio of the EV of a company to its earnings before interest and taxes (EBIT). EBIT is a measure of operating profitability that includes depreciation and amortization, but excludes interest and taxes. This method is similar to the EV/EBITDA method, but it accounts for the impact of capital expenditures and asset depreciation on earnings. The exit multiple is based on the average or median EV/EBIT ratio of comparable companies in the same industry or sector.

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4 Equity value to net income

This method calculates the ratio of the equity value (EV) of a company to its net income. EV is the market value of equity, which is equal to the share price multiplied by the number of shares outstanding. Net income is the bottom line of the income statement, which reflects the profit or loss after deducting all expenses, including interest and taxes. This method is often used for companies that have low debt levels and consistent earnings, as it shows the return on equity for shareholders. The exit multiple is based on the average or median EV/net income ratio of comparable companies in the same industry or sector.

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Sanjay H

Consulting Chief Financial Officer | 23+ Years in Strategic Leadership | Corporate Financing I Advisory I
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I do not think this method is widely used in valuation. That is because of the inclusion of Net Income in the denominator. NI is the bottom line of the PnL after deduction of all expenses including TAX,DEP and Interest. So method is more useful for evaluation of short term profitability and ignores growth and risks associated with growth. Capital structure is also not considered

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5 Equity value to free cash flow

This method calculates the ratio of the EV of a company to its free cash flow (FCF). FCF is the cash flow from operations, minus capital expenditures and changes in working capital. FCF represents the cash available for shareholders, debt holders, and potential acquirers after reinvesting in the business. This method is often used for companies that have high cash generation and low capital intensity, as it indicates the value creation potential of the company. The exit multiple is based on the average or median EV/FCF ratio of comparable companies in the same industry or sector.

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Radek Nemecek

IR Manager / Capital Raising / IPOs
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Prefer to use Enterprise value/FCF i.e. including net debt in the calculation. Personally my preferred valuation metrics although fluctuations in the FCF company's cycle might distort the comparative analysis.

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6 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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Sanjay H

Consulting Chief Financial Officer | 23+ Years in Strategic Leadership | Corporate Financing I Advisory I
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I would like to add that DCF is one of the best methods and widely used of course with combination of other methods. Though the choice of a method depends on the facts and circumstances DCF has wide acceptance. The main demerit is that its complex and involves so many assumptions in calculations

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What are the most common exit multiples valuation methods?

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1 Enterprise value to revenue

2 Enterprise value to EBITDA

3 Enterprise value to EBIT

4 Equity value to net income

5 Equity value to free cash flow

6 Here’s what else to consider

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