Business Valuations – using “multiples” determined by risk!

Business owners often turn to professional business valuers for an objective estimate of their business. This can be for various reasons, including when selling a business, establishing partner ownership, for taxation purposes, as part of divorce proceedings or when a company is looking to merge with or acquire another company.

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Business owners often turn to professional business valuers for an objective estimate of their business.  This can be for various reasons, including when selling a business, establishing partner ownership, for taxation purposes, as part of divorce proceedings or when a company is looking to merge with or acquire another company.

As business valuers, we are often asked by clients and colleagues about the expected or standard “multiples” used for various industry sectors or business types.   Generally, the idea is to apply these “industry multiples” to revenue or profits and then arrive at the enterprise value of a business.

Our answer to that?  There isn’t one.

The risk factors

That’s because multiples are associated with the risk of a business, or simply put, a measure of how much risk is associated with that business and, therefore how quickly you might want your investment returned.  Valuing a business is like valuing any investment – you base the purchase price on the expected future cash flows you will receive over time.  Those cash flows, because they are unknown with certainty at the time of the purchase or investment, have an inherent risk that they won’t eventuate for any number of reasons.

Two scenarios

To put that in simple terms, you might decide to purchase a business that is expected to produce $200,000 per annum in free cash flow, i.e. your returns on your investment.  Now if you considered that cash flow to be pretty certain – maybe it has good contracts in place, good trading history, good management and so on – you might be willing to wait six years for your investment to be recouped.  So, your multiple that you would pay on the expected $200,000 per annum would be 6, or a purchase price of $1,200,000.

Similarly, if the business was riskier – it was a start-up business, inconsistent trading results, uncertain markets and the like – you would want your money back more quickly.  So perhaps you only give it three years to recoup your investment, so your purchase price would be significantly less at $600,000.

Remember that the money paid for the purchase of the business is essentially your equity in that business, so you bear the equity risk of that investment and therefore want your entire capital back in a relatively short period of time.  That’s different to a return on funds invested, which could be equivalent to interest or dividends earned.

Businesses are different

Businesses are unique objects in that they all trade very differently from each other depending on size, markets, experience and knowledge, business models and a myriad of other reasons.  It is, therefore, unrealistic to expect the risks associated with one company to be the same as those associated with another company, unless they are operating at exactly the same levels, in exactly the same way, and have exactly the same history and structure.

So that’s why there is not a “one size fits all” multiple for industries and businesses – the benefit of getting a decent valuation involves an in-depth assessment of the likely risks attached to that specific business.  It is not just an average number that is likely to be irrelevant.

The public market

Having said that, when we do calculate multiples for the businesses we are valuing, we do have regard to the multiples that are represented by transactions of shares in the public market, mainly because this is the most common and freely available data in relation to sale transactions.  However, these are still an average of any number of transactions in the market at any given point in time, and they also vary materially from month to month.

The specific business factors

But even using these as a starting point, our analysis and calculations consider the factors that relate specifically to the business we are valuing.  We look at the history, the financial performance, but also the risks associated with how the business operates.  For example, does the business have too much reliance on a limited number of suppliers or customers?  Does it operate in an industry that is in decline or maybe has potential growth instead?  Is there too much reliance on the key personnel?

Reliance on key personnel is something we see quite often, particularly when valuing small-to-medium sized businesses created and run by families, often with control in the hands of one or two key family members.  Small businesses operating in this way have their own quirks and issues, often around dictatorial management styles, lack of transparency and lack of documented systems and processes.  Added up, this presents potential significant risks for any incoming purchaser who would see difficulties in being able to acquire the business and then expect to continue operations immediately after.

What does history reveal?

History is also a key factor.  For example, recently we were asked to prepare a valuation report for a business that had been operating for some years, established by the current owner and making profits but was somewhat stagnant in growth and new markets.  Enquiries revealed that the business had experienced issues with product quality and customer complaints.  That indicates to us that there could be a risk of underlying and systemic issues around quality control – and that could have a detrimental impact on the likely value of the business, even without in-depth due diligence being conducted!

In summary

All these and other factors indicate different levels of risk that are relevant to that business only, and they will inevitably have an influence on the end calculation of the multiple.

Business valuations play a critical role in business, but if the valuation does not correctly look at the likely risks of the business being acquired, it can reflect distorted values for the business, and that will end up with the potential purchaser or seller basing decisions on the wrong information.

In summary, business valuations should be carried out by specialists with the experience to do the necessary due diligence.  This ensures you are going into negotiations with the most accurate information, which may even save time and money in the long run.

dVT Group has many years of experience in assessing businesses and preparing valuation reports and understands risk in business.

Should you wish to discuss any of the above, please contact Suelen McCallum on 02 9633 3333 or

dVT Group is a business advisory firm that specialises in business strategy, turnaround, forensic investigations, and insolvency (both corporate and personal). 



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