Small Business Investing

Private Equity

How does a valuation multiple help me understand the price paid to acquire a company, or to value a target company?

A valuation multiple is a key metric used to express an asset’s current market value. The metric used must be highly correlated with the financial performance of the company, and although quite simplistic, comparing this multiple to other peer companies and/or transactions will give prospective buyers a rough idea if they are underpaying or overpaying for an asset. For example, a company that creates $1 billion in sales might be sold to a private equity firm for $2 billion (or valued at a multiple of two times sales). In another example using earnings, if this same company generates $200 million in profit per year (or valued at a multiple of ten times earnings), and we compare this multiple value with other similar transactions, again we may see if the target company is selling at a premium or a discount to the private equity investors.


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