Thursday, 24 January 2013

What Dictates the Multiplier Used to Value a Company?

How to Value a Company Using Multipliers

When selling or buying a Company, understanding the factors that drive the valuation is crucial.  In general terms, factors that dictate the multiplier include:

1.  Supply & Demand – Companies in attractive, high demand industries will command a higher multiplier than those in more basic or out of favour sectors.  Today, healthcare and high tech are two examples of high demand industries which are generating very attractive multipliers.  The supply aspect is also critical.  If there are plenty of attractive, profitable and well managed operations on the market (i.e oversupply) prices will generally be lower as it will be a ‘Buyers’ market’.  On the other side, if there is a high demand but a low number of quality Companies being sold, this will lead to Buyers paying a premium.  As a Vendor therefore, timing the sale of your Company to coincide with when the demand in your market is at the highest will lead to the highest value being achieved.  Many Vendors I speak to think wrongly that increasing their profitability is the only aspect they need to focus on, when in fact the question of how to value a Company involves more variables than this.  A Company could be worth more with less profits if they time the sale right, potentially allowing them to exit earlier than they perceived.

2. Growth – Despite every Buyer focusing on the last 12 months to 3 years of earning, Purchasers are buying the future.  What ultimately matters to a Buyer is not what your Company earned last year, it’s what the Company could earn in the future once they own it.  Therefore businesses with high potential growth rates will sell for higher multiples than slow growth Companies. 

3. Risk – As mentioned, Risk plays a role in every business decision.  It is common knowledge that safer assets have lower rates of return than high risk investments.  The more risk a Buyer is willing to take, the higher return they will demand.  Therefore a Buyer will offer less for a Company that they perceive carries a lot of risk.  As a Seller there are ways to mitigate the risk

4. Volatility – This is closely related to Risk, though it is linked with external factors rather than competition or dependency on clients.  When determining how to value a Company, if the industry that a Company operates within is heavily influenced by external factors, then the future earnings of the Company are less secure, and therefore a Buyer will look to protect their investment accordingly.  For example, those Companies operating within the Public sector are subject to cuts in spending or budget changes which occur often when new Governments are elected, therefore if the sale is closely timed to a General Election then a Buyer will take this into account when making an offer.  Likewise those Companies operating in the Lettings/Estate Agency sectors, or those linked within the wider Construction industries, are linked to external factors such as the Property Market and the economic climate, not just for the UK but the Eurozone and USA.  A final example is Recruitment Agencies or Training operators, whose revenue streams are heavily influenced by Employment levels and the Private sector, therefore experiencing peaks and troughs with growth years and recessions accordingly.

5. Synergetic Values & Savings – A strategic Buyer will often pay more for a business if they believe the combination has many synergies as well as the opportunity for cost reductions.  These types of Buyers are more likely to pay a ‘premium’ to secure a deal, rather than risk the target Company being acquired by a competitor and potentially threatening their Company going forward.  

Adam Croft, Senior Business Broker

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