How often have you heard someone say that their business is valued at 3 x earnings?

In reality most small to medium business, that turnover between $1 to $10 million, normally have a capitalisation multiple somewhere in the range of one to five.

In establishing the earnings multiple, a review is undertaken of publicly listed companies that are comparable to the business.  Clearly none of these companies will be the same as the business under review as they are much larger and more diversified.  They do however provide some reference point.  Whilst not absolute, the differential in capitalisation rates between a small to medium business and a publicly listed entity is in the rage of 20-40% of the multiple of that a similar business trading in the public market.

Determining the appropriate capitalisation rate to apply to a business is a matter of comparing the specific factors of the business being valued to other companies.  The key points that are reviewed when setting the capitalisation rate are as follows:

• Comparison of growth rates
• Scale
• Market position
• General attributes of the business
• Industry in which the business operates
• Stage in the business life cycle
• Asset backing
• Exposure to risk
• Level of gearing
• Marketability
• Price earnings benchmarks
• Price earnings historical performance