Understanding Capitalisation Multiples: A Key Tool for Business Valuation

When it comes to valuing a business, capitalisation multiples are one of the most widely used and effective methods. This blog post will explore what a capitalisation multiple is, how it is used to value a business, and the different types of capitalisation multiples, including EBITDA multiples, EBIT multiples, and PEBITDA multiples.

1. What is a Capitalisation Multiple?

A capitalisation multiple, often simply called a "multiple," is a financial metric used to value a business. It represents the ratio of a company's market value to a specific financial metric, such as earnings, revenue, or cash flow. Multiples provide a way to compare companies of different sizes within the same industry and to assess the relative value of a business.

2. How is it Used to Value a Business?

The process of using capitalisation multiples to value a business typically involves the following steps:

• Select the Appropriate Multiple: Choose a multiple that aligns with the key financial metrics of the business you are valuing. Commonly used multiples include EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), EBIT (Earnings Before Interest and Taxes), and revenue multiples.
• Determine the Financial Metric: Calculate the relevant financial metric (e.g., EBITDA, EBIT) for the business being valued.
• Find Comparable Companies: Identify comparable companies in the same industry and with similar financial profiles. Analyze their multiples to establish a benchmark.
• Apply the Multiple: Multiply the chosen financial metric of the business by the benchmark multiple to determine its valuation. For example, if the EBITDA multiple is 5x and the business's EBITDA is $2 million, the valuation would be $10 million. It's important to understand that the capitalisation multiple is used to value the operational business, however in order to value an entity (such as a company, corporation, trust, or partnership, the valuer will also need to consider the value of any surplus assets (such as excess cash, loans, income tax receivables, and deferred tax assets) and subtract the value of any financial liabilities (such as bank loans, overdrafts, loans from shareholders, income tax liabilities and provision for income tax).

3. Different Types of Capitalisation Multiples

There are several types of capitalisation multiples, each focusing on different financial metrics. The choice of multiple depends on the nature of the business and the purpose of the valuation. Here are some of the most commonly used multiples:

EBITDA Multiple

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) multiple is one of the most popular valuation multiples. It measures a company's overall financial performance and is often used in industries with significant capital investments.

• Calculation: Market Value / EBITDA
• Use: Ideal for comparing companies with different capital structures, as it excludes interest and taxes. It also excludes non-cash expenses like depreciation and amortization, providing a clearer picture of operating performance.

EBIT Multiple

EBIT (Earnings Before Interest and Taxes) multiple is similar to the EBITDA multiple but includes depreciation and amortization expenses. It is often used for companies where these non-cash expenses are significant.

• Calculation: Market Value / EBIT
• Use: Useful for comparing companies with similar depreciation and amortization policies. It provides insight into the company's profitability before interest and tax expenses.

PEBITDA Multiple

PEBITDA (Pro-forma EBITDA) multiple is a variation of the EBITDA multiple that adds back the owners' remuneration to the profit of the Business. It is commonly used to value micro and small businesses where the profit of the Business is less than the market based remuneration of the owner.

• Calculation: Market Value / PEBITDA
• Use: Ideal for valuing small businesses.

Conclusion

Capitalisation multiples are a powerful tool for business valuation, providing a straightforward way to assess the value of a company based on its financial performance. By understanding and applying different types of multiples, such as EBITDA, EBIT, and PEBITDA multiples, investors and business owners can make more informed decisions about buying, selling, or investing in businesses. Whether you're looking to value a small startup or a large corporation, capitalisation multiples offer a reliable and effective method to determine a company's worth.