Why revenue multiples aren't very helpful
16 June 2015
In some industries people talk about multiples of revenue when working out what their business could be worth. It has some relevance in some industries which use it as a metric (financial services/advisory for example) and in early stage businesses where profit is an alien concept.
However for the most part it needs to be used with care as a secondary measure - and here's why.
Revenue is generally a poor indicator of value. Its rather like focussing on cost per square foot of an office building. But assessing the price for accommodation as rental/square foot will be driven by other factors, including quality but above all by location. Or location location location. So office space in a fenland village, for example, is going to be less per square foot than in Station Road Cambridge.
When we're selling a business potential buyers look at a number of financial metrics of which revenue is one. But of course its not the only one, and as you'd expect profit is usually most important. Specifically EBITDA as it can be a good proxy for cash generation. A buyer will also be looking at qualitative aspects of the business or value drivers, that will influence its price/valuation. These might include perceived weaknesses such as customer concentration or over dependence on the vendor. In contrast positive value drivers could include having a strong intellectual property portfolio or significant market share/quality customers.
Business typically don't sell for multiples of revenue but for fractions of revenue as the chart (of US data) below shows
What this does show clearly is that revenue multiples vary over time and by sector.
So when a company sale is reported as being an impressive multiple of revenue its probably because it has some other factor driving the sale - technology and intellectual property for example.
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1 x revenue is the default valuation of a publishing company. I have long suspected that many executives don't even realise there is a difference between value and turnover.
How do you move a buyer off that metric, when there is such a strong tradition of it?
Posted by: Ian Grove-Stephensen | 29 June 2015 at 08:10 AM