Businesses must conduct formal valuation before buying a business, selling a business or merging with another business. However, business must also value their company one or two times a year to keep track of progress and for planning. Informal valuations may be completed internally by the owner or his delegate.
The secret sauce for any valuation is coming up with a valuation multiple. Rule of Thumb valuation is one approach to determining a multiple for your business. Rules of thumb are established from previous business sales. Businesses can get the rule of thumb for an industry from the respective industry association or a business broker who specializes in the industry. For example, Grocery stores are valued at 15% of annuals sales + inventory. However, many times the rule of thumb is not easily available or does not exist. Businesses may also not want to use rule of thumb for valuation. Another approach, discussed at length in this post, is to use market based multiples for valuation. In such cases valuation can be based on publicly traded companies within the same industry.
Enterprise Value (EV) is a commonly used for valuation. Conceptually, Enterprise Value is the take-over the value of a company. It is the net amount of cash required to acquire a business. In the event of a buyout, the acquirer takes on the debt and the cash in the business. So, Enterprise Valuation can be calculated using the following formula.
EV = Market capitalization + Debt + Minority Interest + Preferred Shared – Cash
EBITDA (Earnings before interest, taxes, depreciation, and amortization) is fundamental to valuing a business. EBITDA is a rough estimate of a businesses Free Cash Flow (FCF) and is the most commonly used metric for business valuation. Smaller businesses tend to use Sellers Discretionary Earnings (SDE) for valuation, which is also derived from EBITDA.
Once a business calculates its EBITDA the business value can be calculated by multiplying EBITDA with the Market Valuation Multiple. Market valuation multiple by industry is listed in table below. The following steps and assumptions were used to calculate the market multiple:
- US public company data has been used to calculate the multiple as such the data may not be relevant in other countries.
- Data is used in the calculation is from 2nd-Jan–2013.The EV / EBITDA multiples may have changed in the last few months.
- All public companies have been classified by industry.
- Step 1: Calculate EV / EBITDA for each company in the US (includes NYSE and NASD).
- Step 2: Calculate the average EV / EBITDA for each industry.
- Step 3: Public companies are much larger and demand a premium. So, we have discounted the multiple by 25%, 33% and 50%. The table includes the original values as well, so you may discount it by a different amount for you industry
Market Multiples Business Valuation
|Industry||EV/EBITDA||(EV/EBITDA) Discount 25%||(EV/EBITDA) Discount 33%||(EV/EBITDA) Discount 50%|
|Financial Svcs. (Div.)||14.660||10.995||9.822||7.330|
|Natural Gas Utility||9.960||7.470||6.673||4.980|
|Packaging & Container||7.200||5.400||4.824||3.600|
|Heavy Truck & Equip||9.530||7.148||6.385||4.765|
|Engineering & Const||13.240||9.930||8.871||6.620|
|Metals & Mining (Div.)||16.270||12.203||10.901||8.135|
|Electric Utility (East)||9.210||6.908||6.171||4.605|
|Electric Util. (Central)||10.210||7.658||6.841||5.105|
|Electric Utility (West)||8.300||6.225||5.561||4.150|
|Med Supp Invasive||25.060||18.795||16.790||12.530|
|Natural Gas (Div.)||14.550||10.913||9.749||7.275|
Disclaimer: Businesses must work with a business professional such as a business broker or chartered accountant (CA) to get a formal value for their business. The techniques described here can be used for informal internal valuations.