M&A Valuation Decoded - Multiples, Factors, Methods, and More

Using the right M&A valuation process is critical to achieving fair and accurate business pricing that you and your potential buyer can agree on.

However, evaluating an M&A transaction requires extensive research, and deciding which valuation technique is the most appropriate can be challenging given many crucial factors.

In this guide, we'll discuss the factors, challenges, and methods you need to consider to value your business accurately for a successful sale.

If you want to leave the process to experts, hire Exitwise. We help you find and collaborate with the best M&A professionals in your industry who can streamline the valuation and sale process.

Plan a consultation session with us at your convenience to discuss how we can help you.

What is an M&A Valuation Model?

An M&A valuation model is a holistic framework or process for estimating and verifying the monetary worth of a business or company due for a merger or acquisition.

Depending on the preferences of your M&A advisory team, the merger and acquisition valuation model may include the following aspects:

• Assumptions to be made

• Appropriate M&A valuation methods to be used

• Expectations of the seller and potential buyers

• Types of experts to be included, such as business appraisers and investment bankers

• The purpose of the valuation (most valuations happen when a company is due for a sale or exit)

• Information available for the valuation, such as internal financial statements and necessary market data

• Factors to be considered, such as the stage of your business's lifecycle, market competition, and business history and reputation

For simplicity, in some cases, an M&A model may refer only to the specific valuation method used.

Importance of Valuation in M&A Deals

The success rate of mergers and acquisitions relies heavily on accurate and fair M&A valuations for the following reasons:

Support for Negotiations and Due Diligence

M&A valuations form the baseline for negotiations to determine the appropriateness of the proposed transaction. Both you and the buyer can justify your independent valuations and agree on a harmonized final price.

The valuation also forms the framework for the due diligence process that assesses your financials, future projections, and historical performance to verify accuracy and validate assumptions.

Obtaining Approvals

An accurate valuation is necessary to get approval for the sale from stakeholders such as shareholders and the government's regulatory bodies.

Identifying Synergies

The valuation process can help you identify and quantify synergies, which can increase the exit value. 

You and the potential buyer can combine your companies' valuations to see the expected synergy and prospective growth opportunities.

Revealing Opportunities for Value Maximization

Since the valuation includes a deep examination of your company, you may discover strengths you could build on or weaknesses you can rectify to maximize your business's value.

Setting Healthy Expectations

The process of valuation in M&A can help you realistically align your idea of how much you can sell your business for so you don't set the sale price too high and discourage potential buyers.

M&A Valuation Multiples Across Industries

Valuations in mergers and acquisitions are often based on multiples because they are easy and fast to apply. 

The NYU Stern School of Business has reliable revenue multiples and EBITDA multiples data:

Note that different types of valuation multiples can differ in the same sector because they measure different financial aspects. 

For example, EBITDA multiples are typically higher because they measure profitability better than revenue multiples. 

Use our handy free valuation calculator to estimate how much your business is worth on a real-time basis based on revenue and EBITDA.

Key Factors that Influence M&A Valuations

As mentioned, the mergers and acquisitions valuation model you use should account for the internal and external factors that can influence the estimated value of your business.

Let's check out some critical factors and how they influence your business's valuation:

While you may not have much control over external factors, you can do your best to improve internal factors to maximize your business's value. 

For example, you may hire key talent long before you decide to sell your company.

Common M&A Valuation Methods

The valuation method you use depends on your business, industry, and valuation purpose, among others. 

Here are common methods to consider:

1. Comparable Company Analysis

A market-based valuation approach, this method compares your company’s financial metrics, like revenue, with other similar companies' in the same sector to see your company's relative valuation. 

The method applies mostly to publicly traded companies.

2. Precedent Transaction Analysis

You can compare the sale prices and multiples of recently sold businesses in your sector or industry to determine the relative value of your business. 

This is a market-based approach.

3. EBITDA Multiple Method

The EBITDA multiple method is also a market-based approach that applies a multiplier to your business's annual EBITDA. Most M&A experts prefer this method because it offers better insights into your business's operational profitability.

Business value = Annual EBITDA x Multiple

Pro Tip: Check out our detailed guide on how many times EBITDA a business is worth.

4. Revenue Multiple Method

You can value your business by applying a market-derived multiple to your annual revenue. The revenue multiple is ideal for fast-growing businesses that have yet to realize their potential profitability.

Business value = Annual revenue x Multiple

5. Seller's Discretionary Earnings Method

If your business has less than $1 million in yearly revenue, you can use the seller's discretionary earnings (SDE) method that applies a market-based multiple to the total monetary benefit you get from your business.

Business value = Annual SDE x Multiple

6. Asset-Based Approach 

The asset valuation method is ideal for businesses or companies with significant physical assets or sellers looking to dispose of their assets rather than company operations.

The asset approach estimates the potential value you can get when you sell off your business assets.

7. Cost-Based Approach

Also called the replacement cost method, the cost-based approach estimates the present cost of building a similar business from scratch. 

Business appraisers identify all your assets and liabilities and assign a current fair market value to each item. The cost to build a similar business (the value of your business) will be the difference between the total values of the assets and liabilities. 

8. Discounted Cash Flow Method 

The discounted cash flow approach uses a discount rate to determine the current value of your business's projected future cash flows.

The sum of the discounted cash flows is added to the terminal value, which is the value of the cash flows beyond the forecast period because you can't project cash flows indefinitely.

Current business value = Sum of discounted projected cash flows + Terminal value

Confused about the best method for your business? You can hire us at Exitwise to help you recruit M&A experts who can help you choose ideal valuation methods. Reach out to us now to kickstart the process.

Challenges in M&A Valuation and Ways to Overcome Them

You may encounter the following challenges during a valuation in mergers and acquisitions:

Overestimating Synergies

In an earn-out system or where you remain an employee in the new entity, overestimating synergies can lead to losses that may affect your earnings. The deal may even fail altogether.

To overcome this, ensure you conduct enough due diligence on the buyer to see if their company is a great fit for yours, where you want to capture synergies in an earn-out or continued involvement system.

You can also estimate synergies conservatively by assuming they will happen steadily but without significant future growth.

Limited Information

Information unavailability can be a huge hindrance to a business valuation. For example, you may not find enough data about recently sold businesses when using market-based valuation methods.

You'll want to hire M&A experts with extensive networks they can leverage to find enough reliable information and proven insights.

You can also apply different mergers and acquisitions valuation methods to have options when you can't use a certain method because some information is unavailable.

Risk and Uncertainty

You may face several M&A risks, such as market volatility, regulatory hurdles, and integration issues. Assessing and quantifying risk can be challenging.

To prevent this, you can do a scenario analysis to assess the effects of different risk factors, integration strategies, market outcomes, and synergy outcomes to develop necessary contingency plans.

Frequently Asked Questions (FAQs)

Let's close with some common questions about M&A valuations:

What Are the Different Types of Valuations?

You can use various valuation types, such as:

• Asset-based approach 

• Discount cash flow analysis

• Cost-based approach (replacement cost method)

• Market-based methods like revenue multiples, precedent transaction analysis, and revenue multiples

At Exitwise, we can help you find the right M&A experts to advise you on the most appropriate valuation method for your business.

How is Synergy Valued in M&A Transactions?

Synergy refers to the value created when two or more businesses merge, and the new entity's value is larger than the sum of the individual values of the merging businesses. 

For a simple synergy valuation, you can subtract the sum of the individual values of the combining businesses from the value of the new entity:

Synergy = Value of new merged entity - Sum of the values of the merging businesses

What Role Does Discounted Cash Flow (DCF) Play in M&A Valuation?

The DCF method discounts the projected future cash flows of your business to their present value using a discount rate to account for the “time value of money".

The discount rate, which is usually the weighted average cost of capital, accounts for the risk associated with your business’s capital structure and future cash flows.

How Do Comparable Company Analysis and Precedent Transactions Influence M&A Valuation?

Since precedent transactions and comparable company analysis rely on market information, they may lead to an undervaluation or overvaluation because of the assumptions applied.

Undervaluation means you are leaving money on the table, while overvaluation can deter prospective buyers and increase the time it would take to sell the business. 

Conclusion

Choosing the right M&A valuation and considering the right factors can help sell your company or business sooner at the highest price possible.

To select the best valuation method and streamline other aspects of the sale, you'll want to work with top-notch experts. 

At Exitwise, we help business owners and founders like you find their ideal M&A team to help them throughout the sale process and maximize their exit.

Chat with our team today to learn more about how our service works and how we can help you achieve the exit of your dreams.