All You Need to Know About Acquisition Multiples
This article discusses acquisition multiple and valuation multiples in acquisition so you can get a more accurate valuation by combining them together.
The acquisition multiple or transaction multiple is an accounting indicator used to determine a company’s worth as a component of the comparable analysis approach of valuation in the framework of merger and acquisition. It gives a statistic predicated on present market trends instead of the underlying worth of the organization being appraised. The kind and source of data utilized determines how valuation and acquisition multiples vary from one another. This article discusses acquisition multiple and valuation multiples in acquisition so you can get a more accurate valuation by combining them together.
Transaction multiples or acquisition multiple
Transaction multiples, also known as acquisition multiples, are a way to evaluate a similar firm by applying precedents from previous merger and acquisition deals. It is predicated on the idea that it is possible to evaluate the company’s worth by looking at the the amount paid by the acquiring business in its previous purchases. Financial analysts working in the business growth, venture capital, and investment banking sectors often employ this form of valuation.
What are valuation multiples?
Valuation multiples are used to estimate a company’s worth by comparing one or more of the company’s main KPIs to the estimated worth of other firms that are comparable to the one being valued. However, many other measures may be used in a valuation multiples study, and business executives acknowledge that no one statistic can capture the whole picture. Some are more generalizable, while others are better suited to certain fields or kinds of businesses. By calculating a few of these ratios, you may get a good feel for the worth of a company.
Types of valuation multiples
The fact that there are several valuation methodologies necessitates the existence of a variety of valuation multiples. The market capitalization of a publicly listed firm may be calculated by multiplying the stock price by the number of outstanding shares. However, this leaves out important details, including the company’s cash reserves and its debt load, from the balance sheet. For this reason, it might be helpful to be aware of the enterprise value of a certain firm.
However, there are instances when the worth is only a monetary figure established by unbiased financial specialists who have knowledge of the market. Since private firms don’t have access to Wall Street valuations during all market hours, this is very helpful for them.
How to use valuation multiples in M&A transactions?
Value may be determined by looking at what a previous acquirer paid for a comparable company merger and acquisition. The board of directors may use these figures to estimate how much their firm might be valued if contacted by comparable purchasers during their process of merger and acquisition. Here are a few of caveats –
- A company’s worth will vary depending on the buyer. To simplify, during a merger and acquisition, acquirers aiming to purchase a firm for strategic reasons, for example manufacturers wanting to fill a vacancy in its line of products or a retailer targeting a new audience, will pay more than financial bidders pursuing an investment.
- To put it simply, if you choose the incorrect measure to concentrate on, all you’ll get is cacophony of wrong answers rather than useful information since there are many aspects that might enter into any particular purchase valuation of merger and acquisition.
How to use valuation multiples to compare companies?
There’s a lot of information floating around on how valuation multiples can be used to compare companies. If you want investors to put money into your business, you need to know what it’s worth and be able to defend it by explaining how you arrived at that amount, how successfully you’ve fulfilled estimates in the past, and what makes your revenue projections for the future so promising. Here are a few considerations to bear in mind when comparing firms using these multiples:
- Verify that the multiple is being calculated consistently across businesses. If, for instance, one firm relies on forecasts for the future while the other utilizes past data in its research, it will be impossible to make any valid conclusions. The same holds true for ensuring that both valuation multiples are utilizing EBITDA when calculating earnings.
- The use of numerous metrics for assessing businesses should be encouraged. Many popular formulae are geared toward various facets of business. It’s good to compare over a few multiples if the firms are truly similar, such as being in the same sector.
What are transaction multiples?
Looking at similar merger and acquisition deals in the past might help you determine a company’s worth in the present and this method is done through financial metrics called transaction multiples, also known as acquisition multiple.
In a merger and acquisition (M&A) process, a firm may be valued using a number of different approaches, such as discounted cash flow and multiples. Acquisition multiples serve a unique function among these approaches since they inform the buyer of the worth of a firm in a certain industry relative to investor demand. It’s useful for learning about average multiples and premiums in a certain market.
Several elements, including the premium a business must pay to acquire a majority share, go into determining transaction multiples or acquisition multiples. The difference between transaction multiples and valuation multiples is partly due to this.
Pros and cons of transaction multiples
There are several advantages of employing a transaction multiple or an acquisition multiple in valuation process. To begin with, acquisition multiples are easy to find as they are available to general public. It provides information on the volume of trades for various asset classes, shedding light on the nature of the market and allowing you the power to negotiate during merger and acquisition discussion.
Acquisition multiples also gives insight on the tactics used by competing teams. Some could explore for merger and acquisition, while others would target smaller businesses. The acquisition multiple range is more realistic than valuation multiple since it reflects the kinds of premiums really being paid.
Despite all these advantages of using acquisition multiple, there are some disadvantages that must be considered before use. Keep in mind that there are pros and cons to any agreement. There is no universal standard by which to compare different transactions. Additionally, selection bias occurs when one transaction is selected over another.
While acquisition multiples are easy to find for the past comparable businesses, publicly accessible information also has the potential to be inaccurate and misleading. Additionally, previous deals may not provide much light on the current one since market circumstances, such as economic development, resource availability, etc., at the time of those transactions may have been very different from the present day.
Lastly, customer contracts, vendor agreements, governance difficulties, etc., may not be accounted for in acquisition multiples and so present an inaccurate image.
How to calculate the acquisition multiple
One would reasonably wonder what factors go into the calculation of an acquisition multiple or transaction multiple by financial experts. There are two potential responses to this question. One of them is rather simple, while the other two are relatively complicated.
In simplified form, everything hinges on how financial analysts classify similar firms and analyze merger and acquisition agreements. In turn, this affects how much they think the targeted business is worth.
The information provided in the elaborate response is somewhat more comprehensive. Let us explain it in further detail.
- Determine the transaction – Using company websites, industry websites, and bloomberg CACs, transactions can be found. Check for press releases, recent activities, or other sections to find out the popular transactions in the industry.
- Determine the right multiple – Once you have the transaction data, you need to filter for type of the business, time of each transaction, revenues involved in it, and the location of the transaction. Why? You want to compare businesses with similar types. Recent transactions are more relevant than the older ones. Companies with similar revenues should be compared. And lastly, businesses in the same location share similar regional factors and challenges.
- Calculate the transaction multiple valuation – When searching for precedents in business dealings, you must take into account three multiples. Despite the fact that these multiples may not provide a totally true depiction of the company, they will be sufficient for making a decision. These multiples are:
- EV/EBITDA – Due to the fact that both EV (Enterprise Value) and EBITDA (Earnings before interest, taxes, depreciation, and amortization) accommodate for debts, investors and financial experts employ this multiple. The ideal EV/EBITDA range is 6 to 15 times.
- EV/Sales – This multiple is important in certain circumstances when EV/EBITDA is ineffective. A start-up has a low EV/EBITDA ratio. And for this reason, analysts employ the EV/Sales multiple for newly established small enterprises. EV/Sales typically vary from 1X to 3X.
- EV/EBIT – It is crucial since it accounts for the business’s maintenance costs. EBIT and EBITDA are not really important for businesses in the technology and consulting industries. Since depreciation and amortization are compensated in EBIT, EBIT is smaller than EBITDA. Consequently, EV/EBIT is often more than EV/EBITDA. EV/EBIT typically ranges from 10X to 20X.
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