The misleading reality of valuation multiples

Valuation is a key discussion topic during an M&A deal. Very often and rightly so, enterprise value multiples are used as a benchmark within an industry. However, if valuation was only about multiples, it would be too simple! Valuation cannot be reduced to applying a multiple on financial KPIs – below are some key perceptions and reality about multiples.

Source: Mergermarket

Perceptions:

1.??????It's simple; it's not so simple, because it depends on which KPI you apply, and whether the metric is normalised, reported, historical or budget etc...

2.??????It's right; even with access to a professional database (see results in the extract from MergerMarket), it is very difficult to get accurate (and real) data points on a representative pool of private deals.

3.??????It's easy to apply; applying multiples to companies of a different type/size/growth factor is by essence, wrong. In principle, multiples should be proportionate to size and growth and in the current market climate, especially to growth.

Realities:

1.??????Practical tool; it is indeed a good way to initiate an M&A discussion and assess if both parties are within a practical range for discussions.

2.??????Relative value; using multiples as a benchmark and analysing the trend of the multiple over time in a given sector may provide an indication of market sentiment.

3.??????Comparability; it is important that granular information is used to ensure that the multiples are derived from transactions that are in fact comparable.

Beyond multiples, there are qualitative factors involved in a deal, especially for people and IP based businesses. The following qualitative criteria are actually more important than multiples to take into consideration during an M&A deal:

1.??????Top-line revenue: Why your value proposition is attractive to your clients?

2.??????Strategic fit: Why the 2 organisations (buyer and seller) are going to create a compelling offer on the market?

3.??????Cultural fit: Why the staff are going to enjoy the new environment and the new journey proposed by both parties?

These three factors should be considered along with a retention mechanism that is formulated to retain the people-based aspect of the deal. Under current market conditions, we see a trend towards earn-out / deferred consideration based on staff and management retention; this is not captured in multiples!