Business Valuation Using An EBIT Multiple.

One of the most common questions I get asked is, “what is my business worth?”, and whilst there are certainly some financial and accounting formulas that could be applied to answer this question, there is also a hell of a lot of work that needs to be done that has nothing to do with finance or accounting, but rather with the commercial and operational issues within the business, that are largely utilized to determine risk.

Risk is an important aspect of this equation – as like any investment. Risk and reward are directly related - in other words, the higher the risk the lower the valuation versus comparative businesses.

EBIT multiples (earnings before interest and taxes) are a commonly used tool to estimate the valuation of comparable businesses. Occasionally, EBITDA multiples are used (earnings before interest, tax, depreciation, and amortization). This method also removes the non-cash expenses of depreciation and amortization and therefore gives you a realistic picture of the cash which might be generated by the business over a period of time. In other words, the reward you can expect for your risk.

The most common way to utilize an EBIT multiple to calculate the value of your business is to find a comparable business and see what EBIT multiple it is currently trading at. Whilst this information is often difficult to find with small privately held companies, it is quite easy to obtain for larger listed companies. In fact, these numbers also called P/E ratio (price to earnings), are published in most of the financial newspapers.

The issue though is that there is a substantial difference between most listed companies and small privately held businesses which inherently involve significantly more risk (and therefore a reduced EBIT multiple).

One method is to take the multiples for listed companies that are as similar as we can possibly find (although this in itself is often difficult) and then discount that back to account for the increased risk in the small privately held business. In other words, a listed company may be trading at a multiple of 9 or 10 times and we would discount that back to account for a number of factors (see some examples below) so the small private company may well be trading on a multiple of 3 or 4 times.

Some of the more common discounting factors relate to management experience and expertise (including the risk of key man dependence), geographic risk (often small businesses are based in one location only), financial and capital risk (small businesses are often restricted in their ability to raise capital or debt to fund further growth and expansion of the business).

There are a number of other issues that we would examine when undertaking the valuation but as you can see in most cases small privately held businesses can be discounted substantially from the EBIT multiples we see on listed corporates.

In order to maximize the value of your small privately held business, it needs to look and feel as much as possible like a large listed corporate and that is often about reducing risk in as many areas as possible.

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ABOUT THE AUTHOR

Ash Playsted - Founder | Paladin Partners

Ash is both a dedicated STRATEGIST and MINDSET tactician who relentlessly pursues his 'higher calling'. Ash been has been building businesses personally plus continuously learning for more than 40 years, all of it deep inside the Mortgage and Finance industry. He's written thousands of loans, hired and mentored hundreds of brokers and business owners, started, built, and successfully exited, multiple award winning Mortgage businesses himself. When he's not immersed helping clients create massive value you can find Ash with his loving family, including his wife Kaz, two children, two dogs, two cats and three parrots! Ash believes in keeping physically and mentally fit and is constantly developing himself through exercise of body, mind and spirit.