Market Approach Overview
Under Market Approaches to estimating business valuation, valuation multiples are applied to a business's earnings or revenue to estimate valuation.
Valuation multiples are ratios between market value and financial benchmarks like earnings and revenue used to estimate business valuation.
- When businesses are sold, the transactions can be used as reference to estimate the value of comparable businesses within that industry
- To make these reference transactions more practical during valuation exercises, ratios between market value and financial benchmarks like earnings and revenue are calculated and aggregated across these historic transactions
- This creates a set of "valuation multiples" that are specific to each industry
- In many industries, as a business grows in size, the valuation multiples they earn increase since they are seen as less risky
- This size effect results in multiples being applied based thresholds of earnings and revenue within an industry
The two most common valuation multiples are EBITDA and revenue multiples.
- EBITDA Multiple: A ratio of the market value (Enterprise Value) to earnings
- Revenue Multiple: A ratio of the market value (Enterprise Value) to revenue
For private small and mid-sized businesses (SMBs) that are well established, EBITDA valuation multiples tend to be relied on more heavily. For pre-revenue or very early-stage companies, revenue multiples become more relevant.
Read more about industry selection and valuation multiples in the Business Industry Selection insight.