In June 2022, the Deutsche Unternehmerbörse established a new framework for valuing privately held companies. The first update to the data has been available since the end of November. It shows that, despite the difficult economic years of 2020 and 2021, optimism about the future has returned in a number of industries since mid-2022, and that even the most recent purchase prices were agreed upon based on the expectation of better future results. Only in the construction industry (and to a lesser extent in mechanical engineering) have valuations become more cautious compared to early summer. In the retail sector, the differences between brick-and-mortar retail and e-commerce also led to a reduction in the ratio.
The new DUB SME Multiples are based on a scientifically sound analytical framework. The multiples are calculated based on actual prices paid for business sales. As such, the multiples also provide recognized benchmarks for the plausibility of tax estimates under the Valuation Act (BewG) (see § 9, para. 2 BewG).
Determining multiples based on actual transactions necessarily requires a standardized evaluation to ensure the reliability of the data set. The DUB multiples are based on the median of the adjusted EBITs for the last three years. For a correct valuation, however, EBIT (earnings before interest and taxes) should be used, assuming that this figure will be achieved on a regular basis in the future. This currently creates a certain contradiction: the two figures do not necessarily match. Many companies show negative or poor results for 2020/2021 in the most recent data analysis; however, the purchase prices were agreed upon based on more optimistic future expectations. This leads to mathematically higher multiples, which should not necessarily be applied to “normal” EBIT expectations but rather critically compared with the individual prospects of the companies newly up for sale.
What is the basic understanding?
At first glance, it seems that valuing a company using multiples is easier than it actually is. Errors in determining the benchmark and selecting the specific multiple value can lead to wrong decisions; in the worst case, they can even prevent a succession from getting off the ground because the seller sets an unrealistically high purchase price expectation as an anchor. Determining a company’s value using the multiples method essentially follows this simple calculation formula
Value = Reference Value × Multiplier
The difficulties in determining value arise from understanding the underlying assumptions and correctly determining the input variables. It is also important to recognize that a professional business valuation generally provides a valuation range, not just a single value. Multiples are divided into those that determine the enterprise value (in the sense of the total value of the assets necessary for operations) (so-called “entity multiples”) and those that directly calculate the value of equity (so-called “equity multiples”). The EBIT multiples published on www.dub.de belong to the first group and therefore show—broken down by 16 industries—the ratio of enterprise value to the company’s EBIT.
Which EBIT? Published or adjusted figures?
For sole proprietorships and partnerships, there is always the issue that the cost of the company’s labor—the so-called imputed owner’s compensation—is missing from the database. Since the published multiples are independent of legal form, the annual costs that would be incurred for an external managing director may need to be deducted from EBIT. The DUB-SME Multiples database now allows for fairly reliable estimates of owner’s compensation across various industries. As soon as the data allows for a retrospective analysis several fiscal years after the transaction, value-enhancing adjustments to multiples may be considered, because well over a quarter of all transactions now include an earn-out provision, that is, a clause providing for a supplementary payment on top of the purchase price in the event of the company’s profitable continuation. Supplementary payments are thus much more widespread than previously assumed.
Past or Future Values?
Since the value of a company is fundamentally derived from its future earnings (see BewG § 11, para. (2), sentence 2), this principle also applies to valuation using multiples. This means that the EBIT to be used as a benchmark is the figure that is expected to be sustainably achieved (on average) in the future. The approach frequently observed in practice—using current EBIT or, encouraged by § 201, para. (1) and (2) of the German Valuation Act (BewG)—to use the average EBIT over the last three years—therefore always leads to technical errors in the valuation whenever the sustainably achievable—i.e., future—EBIT deviates from past values. Even in the absence of a business plan, the appraiser must consider whether the determined value is sustainable. As described above, the current DUB multiples are based, on the one hand, on the EBIT figures of the past three years; on the other hand, they incorporate the future values reflected in the purchase prices. A correct valuation based on future earnings is explicitly determined using an income approach or a discounted cash flow (DCF) method. Due to their high degree of simplification, multiple-based methods are merely a tool used to verify the plausibility of a valuation derived from these methods.
Which industry?
A typical classification of small and medium-sized enterprises involves dividing them into 16 industry groups, each with a distinct risk and opportunity profile. When selecting an industry, similarities in asset and capital structure, business model, and market conditions should be taken into account. For example, if one is dealing with a commercial agency for used agricultural machinery and other specialty vehicles, it makes sense to include multiple industries, weighted appropriately, in the multiplier calculation.
Which benchmark should be used?
EBIT multiples are the most widely used. In addition, the valuer may also have access to EBITDA and revenue multiples. In the case of negative earnings (losses), it is usually unavoidable to switch the valuation to revenue multiples. Furthermore, there is not just “the” multiplier for a given industry, but rather a range within which the results of recent transactions have fallen. “Outliers” resulting from deals in special circumstances can skew these ranges. If such peculiarities are identified when calculating DUB multiples, the extreme values are eliminated from the ranges. The income approach simplified for tax purposes pursuant to Sections 200 et seq. of the German Property Valuation Act (BewG) is also a multiple-based approach. Many tax advisors rely on the profit multiplier of 13.75 prescribed therein. However, this valuation is unrealistic for SMEs and should not be used in relevant transaction mandates. Pursuant to § 199 of the German Valuation Act (BewG), the simplified income approach is also expressly considered only “if it does not lead to obviously inaccurate results.”
The DUB-SME multiples are not the only published purchase price analyses. The available metrics differ, in some cases significantly, in terms of their scientific basis, the quality, quantity, and timeliness of the data, as well as the size of the companies. There are now also numerous business valuation calculators available online. Often, these do not disclose their assumptions, data sources, or calculation methods and are therefore of no value for making an informed decision. They generally serve only to attract new customers or collect email addresses. We will discuss the requirements for a correct valuation using multiples in detail in the upcoming January issue of the journal “PU Praxis Unternehmensnachfolge,” published by the “IWW Institut für Wissen in der Wirtschaft.” In any case, valuation using a multiples method is not suitable for every valuation situation. When in doubt, therefore, one should consider consulting an experienced appraiser.
