When is an EBITDA multiple not a suitable way to value a business?

An EBITDA multiple suits some businesses and not others. The Business Development Bank of Canada (BDC) says several valuation methods are commonly used and that the most suitable combination depends on the purpose of the valuation and the company’s characteristics, such as its profitability, future outlook and asset mix. An EBITDA multiple is one tool, and BDC’s description of where each tool fits shows when it is a poor choice.

Where a multiple fits

BDC says earnings-based approaches are commonly used for established businesses that are generating reasonable returns and whose value is greater than that of their assets alone. It lists market-based methods separately: they apply a valuation multiple, which may be based on EBITDA, revenue or another metric. BDC adds that the figure and type of ratio vary with factors such as industry, company size, market conditions and the multiples used to buy or sell comparable businesses.

Where it fits less well

BDC says asset-based approaches are typically used for businesses whose value is asset-related rather than operations-related, for example in the real estate sector. It says they are also applied when a business generates poor returns or is expected to be liquidated. If the business you are looking at fits that description, ask the valuator why an EBITDA multiple would be the main method.

What EBITDA leaves out

BDC’s glossary states that EBITDA is not equivalent to profit. It does not account for non-operating expenses such as interest on debt, taxes and other costs. Before relying on a multiple, ask which costs sit outside the EBITDA figure and whether the figure is the same one the seller, the lender and the valuator are each using. Two EBITDA numbers for one business are worth understanding before you compare offers.

Cross-checking

BDC notes that professional valuators commonly use multiple valuation approaches to confirm a fair price. BDC’s valuation page also says a valuator’s figure is just a guideline for how to approach negotiations in a sale. Deavo does not value businesses. If you are unsure which approach fits, a qualified business valuator can explain the method behind any number you are given.