Multipliers (or “Earnings Multipliers”) are used in business valuations as way of multiplying the earnings of a business to reflect the true value of a business. The multiplier for a small to midsized business will generally fall between 1 and 3‚ meaning‚ that you will multiply your earnings before interest and taxes (EBIT) by either 1X‚ 2X or 3X. For larger‚ more established organizations‚ the multiplier can be 4 or higher. The question becomes‚ how do you know what multiplier to use? The rule of thumb is that the more closely the business is associated with the person running the business and the less established the business is‚ the lower the multiplier. The more established the business is and the more the business depends on larger and longer-term contracts‚ the bigger the multiplier. There are also other variables which would either increase or decrease your multiplier such as:
(a) Diversification – the less reliant your business is on a few number of customers or products‚ the more consistent your business will be and the multiplier should be increased.
(b) Competition – the level of competition in your industry can either increase or reduce your multiplier. The less competition‚ the higher the multiplier.
(c) Intellectual property – if your business maintains a substantial patent or trademark portfolio‚ the multiplier can be increased. If your business is easily duplicated‚ the multiplier would be lowered.
(d) Industry multiplier – each industry uses a different multiplier when evaluating a business. The industry standard multiplier should be reviewed and your multiplier should be increased or decreased accordingly.
(e) Post closing expenditures – if a buyer coming in would be required to make a substantial investment in the business or there is ongoing litigation/government action‚ that would lower the multiplier.