Does the size of a company really matter where business valuation is concerned? To what extent does the size of an enterprise and its revenue affect valuation multiples?
To answer simply: Yes, size does matter in business valuation. In fact, where multiples are concerned – it matters a great deal.
One only has to study investors eyeing the public capital markets to see this at play.
Larger companies are more established and seen as less risky. This translates into more favorable valuations and subsequently higher price multiples.
For sellers preparing for mergers and acquisitions wondering why larger companies get larger multiples, this blog will give you the answers.
What are the valuation multiples?
Definition
The Corporate Finance Institute defines valuation multiples as:
“…financial measurement tools that evaluate one financial metric as a ratio of another, in order to make different companies more comparable. Multiples are the proportion of one financial metric (i.e. Share Price) to another financial metric (i.e. Earnings per Share).”
This is a sound definition. To put it in our words, valuation multiples are financial benchmarks against which companies can be compared to each other.
With our current economic climate, most sellers are seeking to understand the best ways to increase their multiples so they can position themselves for successful mergers or acquisitions.
Before understanding why larger companies get the larger multiples, let’s look at some of the various types of multiples that exist.
Types of valuation multiples
There exist two major types of valuation multiples and these are:
- Enterprise Value Multiples
- Equity Multiples
Enterprise Value Multiples
Where M&As are being discussed, analysts rely on Enterprise Value Multiples (EVM) to assess the financial standing of a company. The four major EVMs that are used are EV/Revenue, EV/EBITDAR, EV/EBITDA, and EV/Invested Capital.
Equity Multiples
Equity multiples are most often employed by investors seeking minority shareholding in enterprises. Common equity multiples that are applied in investment decision making include P/E Ratio, Price/Book Ratio, Dividend Yield, and Price/Sales.