What it means
Applying a multiple is the quickest valuation technique in common use. You assemble a set of comparable businesses, work out the multiple each traded or transacted at, pick a figure from that range and multiply it by the target's EBITDA.
The result is enterprise value, not the amount the seller takes home. Turning enterprise value into equity value is the step people forget.
You subtract the target's debt and add its surplus cash, because the buyer inherits the borrowings and keeps the cash balances, and this bridge routinely moves the headline number by a fifth or more. Choosing the multiple is where judgement lives.
Comparable companies are rarely genuinely comparable, so the analyst adjusts for size, growth rate, margin, customer concentration and how much of the revenue is contracted. Smaller private companies almost always attract a lower multiple than listed peers, partly because their shares cannot be sold quickly.
EBITDA itself is normally adjusted before any multiple is applied to it. Owner salaries above market rate, one-off legal costs and closed product lines are added back or stripped out to produce a normalised figure, and negotiating those adjustments is often worth more than arguing about the multiple.
The main caution is circularity. A multiple drawn from recent deals reflects the market conditions of those deals, so in a hot market it embeds optimism and in a downturn it embeds pessimism, which is exactly why disciplined buyers cross-check the answer against a discounted cash flow model.
In practice
Real-world examples.
Example
A trade buyer offers 8.5x for a distribution business while a private equity bidder offers 9.5x. The trade buyer explains that it can remove $2,000,000 of duplicate overhead, so its effective multiple on the combined earnings is lower than the headline suggests.
Example
A family-owned bakery group is valued at 6.0x adjusted EBITDA, well below the 11.0x its listed competitor trades at. The adviser explains the gap as a combination of size, the founder's personal relationships with key customers, and the fact that the shares cannot be sold on an exchange.
Example
A board reviewing an approach models the offer at three multiples: 7.0x, 8.0x and 9.0x. Presenting the equity value under each scenario, rather than one number, gives the non-executive directors a far clearer sense of what they are being asked to accept.
Think of it
“EV/EBITDA is like comparing house prices per square foot. It standardizes value so you can fairly compare a mansion to a cottage.
Formula
Calculation
Enterprise value = adjusted EBITDA x chosen multiple
Equity value = enterprise value - total debt + surplus cash
An owner is selling a specialist engineering business. Reported EBITDA is $10,500,000, but the adviser adds back $1,000,000 of above-market owner remuneration and $500,000 of one-off legal fees, giving adjusted EBITDA of $12,000,000.
Comparable transactions in the sector cleared between 8.0x and 10.0x, which on this EBITDA implies enterprise values from $96,000,000 to $120,000,000. The adviser settles on 9.0x for a business of this size and growth rate, so enterprise value = $12,000,000 x 9.0 = $108,000,000.
The company owes $22,000,000 on a term loan and holds $4,000,000 of cash. Equity value = $108,000,000 - $22,000,000 + $4,000,000 = $90,000,000. Every half turn of multiple is worth 0.5 x $12,000,000 = $6,000,000 to the seller, which is why the negotiation focuses so tightly on both the multiple and the add-backs.Case study
Seen in the real world.
Pemberton Coatings is an invented, illustrative industrial paints business created to show how the multiple is negotiated. Its owners engaged an adviser expecting 10x on reported EBITDA of $8,000,000, which they took to mean an $80,000,000 cheque.
Two things changed the picture. On the positive side, add-backs for the founder's excess salary and a discontinued marine line lifted adjusted EBITDA to $9,200,000. On the negative side, bidders anchored at 8.0x because one customer accounted for 34% of sales, so enterprise value came out at $73,600,000 rather than $80,000,000.
Subtracting $14,000,000 of debt and adding $2,000,000 of cash left equity value at $61,600,000. The illustrative moral is that owners should model the debt bridge and the customer concentration discount before setting expectations, because both were entirely visible a year in advance.
Watch out
Common mistakes.
- Quoting a multiple without saying which EBITDA it applies to. Historic, adjusted and forecast EBITDA can differ by 20% or more, and the same multiple on each gives three quite different valuations.
- Treating enterprise value as the price the shareholders receive. Debt has to be repaid out of the proceeds, so equity value is what actually lands in the seller's account.
- Copying a listed company's multiple straight onto a small private business. Private companies typically transact at a meaningful discount for size, liquidity and key-person dependency.
Questions
People also ask.
How do I choose between a range of comparable multiples?
Position the target within the range using growth, margin and revenue quality, and be able to explain in one sentence why it sits above or below the midpoint.
Does the multiple include working capital?
Deals are usually done on a cash-free, debt-free basis with a normal level of working capital delivered, and any shortfall against the agreed level is settled as a price adjustment.
Why do buyers still build a discounted cash flow model?
Because a multiple imports whatever mood the market was in, whereas a cash flow model forces explicit assumptions about growth, margins and investment that can be tested.
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