Exit Multiples: Types, Calculation, and Limitations Explained

Valuing your business for an exit is usually overwhelming, given that you may have to decide on the best exit multiple and apply it to suitable financial metrics to get an accurate sale price.

The good news is that you don't have to decide the multiple and financial metrics alone.

At Exitwise, we help you hire, manage, and work with the finest M&A experts in your industry to help you maximize your business sale.

From M&A accountants and business appraisers to investment bankers, wealth advisors, and corporate attorneys, we'll help you build the ideal team. Secure a consultation with our M&A team today to unlock the secrets to a successful exit.

What is an Exit Multiple?

An exit multiple is a numerical multiplier you apply to a given business financial metric, such as EBITDA, to determine the value of the business before a sale. 

The term may also refer to the financial metrics investors and venture capitalists use to determine the return on investment they receive when selling a business.

Exit Multiple vs. Perpetuity Growth

When it comes to business valuations, you may use exit multiples or the perpetuity growth method. Here's how the two compare:

Note that both the exit multiple and perpetual growth methods can be used as alternatives and complements to each other. However, the latter usually gives a higher terminal and total value than the exit multiple method.

What is a Good Exit Multiple?

There's no one-size-fits-all when it comes to exit multiples. What may seem like a good multiple in one industry may not be suitable in another. The suitability depends on the industry, type of business exit, the business itself, market conditions, and the valuation purpose.

For example, two same-sector businesses with similar operations may have EBITDA multiples of 9x and 11x. Holding all other factors constant, investors may find the one with a lower multiple undervalued and cheaper, making them more likely to buy it because it looks like a better bargain.

Types of Exit Multiples

Depending on the financial metric, you can use the following types of exit multiples when selling your company:

1. SDE Multiple

The seller's discretionary earnings multiple, or SDE multiple, usually applies when valuing smaller businesses with an annual cash flow of less than $1 million that heavily rely on the role of the owner or owner-operator.

The multiple compares the company value to the seller's discretionary earnings.

Your business appraiser often assesses the SDE multiples of recently sold businesses in your industry to determine an accurate average or range for your business.

2. Revenue Multiple

The revenue multiple often applies to high-growth companies or businesses that are yet to reach profitability but have reliable revenue metrics.

The multiple compares the company value to revenue and usually derives from a market assessment of recently sold similar businesses.

3. EBITDA Multiple

The EBITDA multiple is common because it shows a direct relationship between a business’s value and its profits.

Also known as the enterprise multiple, it compares the company value to its EBITDA.

You can get the multiple by comparing the EBITDA sale multiples of similar businesses.

Business appraisers usually use the EBITDA multiple for mature businesses with low capital expenditure and stable profit margins.

Check out the free Exitwise business valuation calculator to estimate how many times your business is worth its annual EBITDA.

4. EBIT Multiple

The EBIT multiple compares the company value to earnings before interest and taxes (EBIT). 

The multiple also shows a business's value in relation to its profits and is calculated by comparing the EBIT sale multiples for similar businesses sold recently.

5. Net Income Multiple

The net income multiple compares the company value to its annual net income and derives from assessing businesses that have recently sold using the same metric.

You can use the net income multiple to value your company if it has consistent earnings and low debt levels to see your short-term profitability while holding growth and the risks associated with it constant.

6. FCF Multiple

The free cash flow multiple is usually used for those businesses that have low capital intensity but generate cash significantly to indicate their potential to create high value.

The multiple compares the company value to its free cash flows and stems from comparing the FCF sale multiples of other recently sold businesses in the same sector.

How to Calculate an Exit Multiple

Calculating exit multiples is easy when you have the company value or enterprise value and a relevant financial metric.

To get the exit multiple, divide the company value by the relevant metric.

Exit Multiple = Company Value ÷ Financial Metric

Exit Multiple Formula

Let's check out the corresponding exit multiple formulas based on the above types of exit multiples:

1. SDE Multiple Formula: SDE Exit Multiple = Company Value ÷ SDE

2. Revenue Multiple Formula: Revenue Exit Multiple = Company Value ÷ Revenue

3. EBITDA Exit Multiple Formula: EBITDA Exit Multiple = Company Value ÷ EBITDA

4. EBIT Exit Multiple Formula: EBIT Exit Multiple = Company Value ÷ EBIT

5. Net Income Exit Multiple Formula: Net Income Exit Multiple = Company Value ÷ Net Income

6. FCF Exit Multiple Formula: FCF Exit Multiple = Company Value ÷ Free Cash Flow

While calculating an exit multiple is relatively straightforward, deciding the type of multiple to use can be challenging.

We at Exitwise can help you hire the finest M&A experts to guide you in deciding the best valuation methods that match your business's unique characteristics.

Schedule a call with us today to learn more about how you can build your dream M&A team for the highest possible profitability.

4 Factors Affecting the Exit Multiple Method   

Here are some factors that may affect the method and potentially your choice of it:

1. Market Conditions

Prevailing market conditions during your exit can be a major factor.

You may want to consider the level of competition, the interplay of demand and supply of capital, the general economic outlook, and the availability of M&A financing. These factors can cause market multiples to vary.

If you expect the market to be favorable during your exit, you may ask for a premium exit multiple derived from your detailed market comparison.

2. Competitive Advantage

If you have a significant competitive advantage, the exit multiple method may favor you more. For example, offering a unique service or product could command a better sale price.

3. Internal Company Characteristics

Your company’s or business's internal characteristics can lead to a lower or higher exit value. The growth rate, risk factors, and financial performance are some aspects to consider.

4. Industry Performance

The general performance of the industry in which your business operates can determine how well or poorly exit multiples affect you. You can enjoy higher multiples if you are in an industry with high growth and profitability capabilities.

Limitations of Using Exit Multiples as a Valuation Method  

Even as exit multiples are ideal for their simplicity and ease of use, they have limitations. Below are some general limitations of using them in exit valuations:

• Estimations and Assumptions May be Wrong: Exit multiple valuations are based on estimates and assumptions that may not remain true in the future. For example, projected earnings, growth rates, discount rates, and even the multiple itself may not be accurate.

• Inadequate Data May Cause Delays: Exit multiples are subject to the availability and quality of data, and not many recent business sales are made public. Also, the representativeness and compatibility of those businesses may not always be optimal.

Frequently Asked Questions (FAQs)

Let's check out some common questions about exit multiples:

Can Exit Multiples Be Used for Startups, or Are They Only Applicable to Established Businesses?

You can use exit multiples to value startups. The most common multiples used to value startups include revenue multiple, EBITDA multiple, EBIT multiple, and FCF multiple.

Are There Any Alternative Methods to Exit Multiples for Valuing a Business?

The perpetual growth method is an ideal alternative to exit multiple valuation methods.

Here’s the formula:

Total company value = Discounted FCFs for the forecast years + Discounted terminal value

Where;

• Present Value, PV, of FCF for the year = FCF for that year ÷ (1 + discount rate)^ the year number = FCF that year ÷ (1 + 0.1)^ the year number = FCF that year ÷ (1.1^the year number)

• Terminal Value = [FCF of the final year x (1 + Perpetuity growth rate)] ÷ (Discount rate - Perpetuity growth rate)

Other methods may suffice:

• Book Value Method: Company Value = Total Assets - Total Liabilities (Ideal when a business has valuable assets but low profits and its intangible assets don't have significant value yet.)

• Cost-Based Valuation: The buyer may replace the costs you incurred when creating the business.

Are There Any Industry-Specific Benchmarks for Exit Multiples?

Even though exit multiples are typically same-industry market comparables, there aren't industry-specific benchmarks for validating the multiples.

You can check out trusted sources like NYU Stern and First Page Sage for reliable industry-specific exit multiples data.

Conclusion

Using an exit multiple can be a great way to determine your business's value because the method is simple. However, it can be challenging to determine the best multiple and financial metric combinations.

We can help you hire experienced and qualified business appraisers to advise you on the best methods for a more accurate valuation and sale price. Reach out to our Exitwise team today to start building your dream M&A team!