Valuation multiples

Key takeaways

• Valuation multiples are ratios that compare a company’s value to a financial metric such as revenue, EBITDA or net income.
• In private equity (PE), they are used to evaluate potential investments, negotiate pricing and model expected returns at exit.
• Common multiples include enterprise value (EV)/EBITDA, EV/revenue and price/earnings (P/E).
• These ratios vary widely by sector, company size, profitability and broader market dynamics.
• Understanding and applying valuation multiples is critical to deal underwriting, portfolio management and exit planning.

What are valuation multiples in private equity?

Valuation multiples are a shorthand way to express how much investors are willing to pay for a company relative to a specific financial metric. In private equity, they help firms benchmark target companies, assess relative value and make investment decisions quickly and comparably.

• EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation and amortisation): This is the most widely used multiple in PE. It removes the impact of a company’s capital structure and non-cash charges, providing a cleaner basis for comparison. It's especially helpful in leveraged buyouts (LBOs) where interest expense can vary widely and is tax deductible.
• EV/revenue: Often used for high-growth or pre-profit companies, particularly in sectors like technology. When EBITDA is negative or unreliable, EV/revenue offers a way to compare value based on topline performance.
• P/E (price to earnings): More common in public equity, the P/E ratio is less emphasised in PE because it includes the effects of leverage, tax strategies and depreciation. That said, it may still be relevant when comparing public comps or exit valuations in IPO scenarios.
• EV/EBIT: Enterprise value to EBIT (earnings before interest and taxes) is sometimes used for mature, cash-generative businesses. Unlike EBITDA, it includes depreciation, making it useful in capital-intensive industries like manufacturing.

Valuation multiples can be calculated on a trailing basis (using historical results) or a forward basis (using projected earnings). Forward multiples are particularly relevant in PE, where investment theses often rely on future performance and value creation.

What affects valuation multiples in private equity?

Valuation multiples are influenced by a range of company-specific and macroeconomic factors:

• Industry trends and sector growth: High-growth sectors like software or biotech tend to command higher multiples due to expected future earnings and innovation potential. By contrast, mature or cyclical industries like manufacturing or retail often trade at lower multiples.
• Company size and growth potential: Larger companies with strong margins, consistent growth and less investment risk typically receive a premium. Conversely, small, niche firms may trade at a discount—though this can also create opportunity for multiple expansion through operational improvement.
• Macroeconomic environment: Interest rates, inflation and overall market sentiment play a major role in determining valuation multiples. In low-rate environments, risk assets become more attractive, often pushing up these multiples. Conversely, high inflation or economic uncertainty can compress multiples as investors become more risk averse.
• Geographic and regulatory considerations: Companies in stable jurisdictions with favourable regulation and legal protections often attract higher valuations. Emerging markets or regions with political risk may see lower multiples, even for high-quality assets.
• Buyer competition: Multiples often rise in a seller’s market, where strategic buyers and financial sponsors compete aggressively for deals. Conversely, in buyer’s markets or periods of uncertainty, sellers may have to accept lower valuations.

Strategic use of multiples in private equity

Private equity firms don’t just observe multiples—they use them actively as part of their value creation strategies.

• Entry vs. exit multiple arbitrage: Buying companies at lower multiples and selling them at higher ones is a classic route to generating returns. This can be driven by improving the business or market dynamics shifting in the private equity fund’s favour.
• Multiple expansion: By improving margins, accelerating growth or professionalising operations, PE firms can justify a higher exit multiple. For example, a fragmented industrial company might receive a 6x EV/EBITDA on entry but command 10x after operational improvements and strategic repositioning.
• Roll-up strategies: Acquiring smaller, lower-multiple companies and integrating them into a platform company can lift the overall valuation. This “multiple uplift” from scale and synergy is a common tactic in PE.
• Sensitivity analysis: Valuation multiples are a core component of LBO models. PE firms stress-test exit scenarios by modelling outcomes at different multiples to assess how much of the return comes from operational improvements versus multiple expansion.

Valuation multiples vs. intrinsic valuation methods

Valuation multiples are part of the relative valuation toolkit, offering quick and easy comparisons between similar companies. They are often used alongside intrinsic valuation methods such as discounted cash flow (DCF) analysis.

• Pros of multiples: They are fast, widely accepted and based on observable market data. Multiples are especially useful when benchmarking companies within the same industry or when DCF inputs are uncertain.
• Cons of multiples: They can oversimplify a company’s value and don’t account for factors like brand strength, customer loyalty or management quality. If the benchmark group is misaligned, reference multiples can be misleading.

The best practice is to use a triangulated approach, combining both multiples and DCF to arrive at a balanced valuation view. This helps mitigate the limitations of each method and ensures a more comprehensive analysis.

Limitations of valuation multiples

While useful, valuation multiples are not foolproof:

• Accounting distortions: EBITDA can be manipulated through aggressive accounting or one-off adjustments. Differences in revenue recognition or capital expenditure policies can also distort comparability.
• Market hype: In frothy markets, multiples can be inflated beyond what fundamentals justify—especially in tech and other speculative sectors. This can lead to overpaying for growth that may never materialise.
• Intangibles and synergies: Multiples often ignore intangible assets like brand equity, IP or customer networks. Strategic buyers may be willing to pay more due to synergies not reflected in base multiples.
• Benchmarking challenges: Selecting appropriate comparables can be difficult. Public companies may not be directly comparable to private companies due to their different scales, disclosure levels and capital structures.

Valuation multiples are a core part of the private equity playbook, used at every stage from deal sourcing and pricing to exit planning and return modelling. They offer a fast, market-based snapshot of a company’s estimated value—but must be interpreted carefully and in context. Used wisely, in combination with other tools like DCF, valuation multiples can guide better dealmaking decisions and support robust investment theses.