The Foundation of Valuation: What is a "Multiple"?
When valuing a business, especially a profitable SME, one of the most common methods is the "multiples approach." In essence, this involves taking a key financial metric—most often EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)—and multiplying it by a figure known as a "multiple." The resulting number provides an estimate of the company's Enterprise Value.
Formula: Valuation = Financial Metric (e.g., EBITDA) x Industry Multiple
While the formula is simple, the complexity lies in determining the correct multiple. A multiple is not an arbitrary number; it is a reflection of market sentiment, risk, and growth expectations for a particular industry. For a UK SME owner, understanding what drives these multiples is the first step toward understanding the true potential value of your business.
Why Do Multiples Vary So Much Between Industries?
You may hear that a software company is valued at a 10x multiple, while a traditional manufacturing business is valued at 4x. This significant difference is driven by a range of factors that investors and buyers use to assess the future potential and risk associated with an industry.
1. Growth Prospects and Scalability
Industries with high growth potential naturally attract higher multiples. A software-as-a-service (SaaS) business, for example, can often scale its customer base with minimal additional cost, leading to exponential growth. In contrast, a construction firm's growth is often tied directly to its physical capacity to take on new projects. Investors will pay a premium for the potential of rapid, scalable growth.
2. Profitability and Margins
Industries with inherently high gross profit margins are seen as more attractive. A high margin indicates efficiency and pricing power. It means that for every additional pound of revenue, a larger portion falls to the bottom line. This financial efficiency is rewarded with a higher valuation multiple.
Capital-intensive industries like manufacturing often have different valuation multiples than tech companies.
3. Recurring Revenue and Predictability
One of the most powerful drivers of high multiples is the quality and predictability of revenue. Businesses with long-term contracts, subscriptions, or a loyal, repeat customer base are less risky than those that rely on one-off projects or sales. This predictable cash flow provides stability and makes future performance easier to forecast, a quality that buyers value highly.
4. Capital Intensity
How much capital is required to generate profit? A business that needs significant ongoing investment in heavy machinery, inventory, or property (high Capital Expenditure or "CapEx") will typically have a lower multiple. The need to constantly reinvest profits just to maintain operations reduces the free cash flow available to owners and investors.
5. Competitive Landscape and Barriers to Entry
How easy is it for a new competitor to enter your market and take your customers? Industries with high barriers to entry—such as those requiring significant upfront investment, specialised knowledge, or strong regulatory approval—are more defensible. This "moat" around the business protects future profits and justifies a higher multiple.
Finding the Right Multiple for Your UK SME
While industry averages provide a useful benchmark, the specific multiple applied to your business will be unique. An acquirer will start with the industry average and then adjust it based on your company's specific strengths and weaknesses.
- Strengths that Increase Your Multiple: A strong management team, a diverse customer base (low customer concentration), proprietary technology or processes, and a history of consistent, above-average growth.
- Weaknesses that Decrease Your Multiple: Heavy reliance on the owner for all key decisions and relationships, high customer churn, outdated technology, and inconsistent financial performance.
Conclusion: A Multiple is More Than Just a Number
Understanding industry multiples is about more than just finding a number to plug into a formula. It's about understanding what the market values. By analysing the factors that drive multiples in your sector, you can gain invaluable insight into the strengths and weaknesses of your own business. This knowledge empowers you not only to get an accurate valuation today but also to make strategic decisions that will build a more valuable company for the future. Our valuation tool uses up-to-date data to provide an indicative multiple for your sector, giving you a powerful starting point on your valuation journey.