Valuators use the Market Approach as one of the ways to determine the value of a company. Using comparable data from completed transactions we can derive valuation multiples. Mostly, we consider purchase price to sales, purchase price to SDE (seller’s discretionary earnings) and purchase price to EBITDA (earnings before interest, taxes, depreciation and amortization).
Quarterly, a publication comes out Pratt’s Stats Private Deal Update that provides general trend information with valuation multiples diced up between industry segments, revenue size and other data points. A juicy read for us valuation geeks. Here is a brief overview of the what I found to be most exciting in the 2nd quarter 2018 update:
- Small companies with revenue under a million still yielded the highest gross margins and operating profits yet the smallest valuation multiples.
- As a percentage of revenue, companies over $5 million and those between $1 and $5 million are very similar yet companies over $5 million get higher multiples. This could be due to companies with higher revenues being more likely to be acquired by public buyers.
- Most of the transactions occur in the services, retail and manufacturing segments.
- Gross profit does not directly correlate to valuation multiples. Some industry segments garner higher multiples when compared to others regardless of profitability. For example, the highest valuation multiples in this quarterly update were in wholesale trade which had the lowest gross profit margins of the nine sectors considered.
- In every industry segment, public buyers paid two to three times what private buyers paid.
It is really important to understand the dynamics behind valuation multiples. Understanding the size differences, industry dynamics and buyer profiles that influence the multiple is imperative to the valuation process. And remember applying average multiples to a company that is not average doesn’t make sense – don’t be lazy! A simple analysis of the underlying data can yield a wealth of useful information.