What a rule of thumb can tell you
A rule-of-thumb valuation applies a simplified measure, often a multiple of revenue or earnings, to estimate a broad indication of value. It can support an initial discussion or reasonableness check, but it does not explain all the factors that determine a particular business's value.
A multiple taken from another transaction is meaningful only when the businesses and terms are sufficiently comparable. The number alone does not establish that comparability.
Check the measure being multiplied
Revenue, operating profit, EBITDA and owner-adjusted earnings are different measures. Confirm the definition and make the same adjustments consistently across comparisons. Review one-off items, owner remuneration and any costs missing from the accounts.
Also distinguish enterprise value from the value attributable to equity. Debt, cash and other adjustments can materially change what owners would receive.
Understand the limitations
- Customer concentration and contract durability.
- Dependence on the owner or key staff.
- Working-capital needs and capital expenditure.
- Growth assumptions and margin sustainability.
- Debt, liabilities and legal or operational risks.
- Deal structure, control and the valuation purpose.
A shortcut can obscure these differences. Two businesses with similar revenue may have very different cash generation, risk and funding needs.
Use more than one perspective
A fuller valuation may consider income, market and asset approaches as appropriate. The selected method should fit the business, evidence and intended use. Explain why a method is relevant and how sensitive the conclusion is to the main assumptions.
Do not combine incompatible measures merely to produce an average. A useful cross-check explains the differences between results rather than hiding them.
Prepare a defensible briefing file
Supply financial statements, management accounts, forecasts, debt and cash details, major contracts and known risks. State the valuation date, ownership interest and purpose. Identify assumptions needing further evidence.
A professional valuation should explain its basis and limitations. No adviser can promise a permanently fixed value or a perfectly accurate future sale price. An actual transaction also depends on negotiation, due diligence, funding and the terms agreed by the parties.
