Last Updated on December 13, 2022 by Anda Malescu
The article discusses about small business valuation multiples by industry.
Valuation multiples are used as part of the market-based approach to value a business. There are two widely accepted methods under this approach – the comparable transactions method and market multiple method.
The comparable transactions method uses data from recent acquisitions of companies that are comparable to the one being valued in order to estimate ratios such as price/earnings, price/cash flow or EV/EBITDA. After that the obtained ratios are used to value the company in question. The market multiple approach uses the same multiples, but instead of deriving them from similar transactions, it uses data from comparable companies that are publicly traded.
The market multiples method assumes the stock market provides an accurate valuation of the comparable company. That brings us to the question how small business valuation multiples by industry are derived. Based on the two methods described above they can either be taken from merger and acquisition data of small businesses or from data coming from public companies.
Using data derived from mergers and acquisitions of small businesses seems like the best choice for obtaining small business valuation multiples by industry. It has the advantage that private company transaction data already reflects the smaller-size, lack of diversification, weaker market position and reliance on the owners that is typical for smaller businesses.
However, before using this data, a valuation professional would need to make sure that:
• The multiples are derived from recent data, usually past 2 years is good.
• The data used to calculate the multiples is in fact correct. This is important because private companies are not required to disclose their financials and the quality of their reporting might be lower. In addition, excess owner compensation can distort key earnings measures such as net income and EBITDA.
• The companies whose transaction data is used to calculate the small business valuation multiples by industry are actually classified in the correct industry. That could be challenging as the limited information on private business might put them in the wrong industry code.
• Finally, to calculate small business valuation multiples by industry we need merger and acquisition data from companies that are in fact small. Being private is not enough as with the rise of private equity firms many larger businesses have become privately-owned. The Small Business Administration provides a definition for what is a small business for each major industry. Another approach would be to seek datasets with similar size to the business that is being valued.
Using data from publicly traded companies can also be useful when calculating small business valuation multiples by industry. This has the advantages that there is more reliable data on the financials of the companies and the continuous trading ensures that valuations are recent and therefore correspond to current market conditions. Companies trading on a stock exchange have to be transparent and report audited financial statements annually and unaudited financial statements quarterly. The biggest disadvantage in using data from publicly traded companies is that even the smaller capitalization companies are usually much larger than their small private counterparts; they are also much more diversified, sometimes operating in several industries simultaneously. To overcome this challenge, valuation professionals adjust multiples from public companies by applying discounts for lack of diversification and smaller size.
Using datasets of small business valuation multiples by industry can be challenging and requires some digging into data before using them. To make sure your business is valued realistically you need to retain a certified professional.
Contact us, your business attorney in Miami, Florida USA if you need advice on retaining a certified business valuation professional.
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