Business Valuation Methods Used in M&A

Why M&A uses more than one method

A valuation method turns evidence about a business into a number, and each method uses different evidence: what buyers pay for a year of profit, a forecast and a view of risk, the balance sheet, or completed deals. The methods rarely agree, and the differences are usually the most useful thing the exercise produces. This guide takes each method in turn — the question it answers, its inputs, strengths, weaknesses and the errors people make — and then explains how to blend them into a range. The process around the methods is in how to value a private company in the UK.

Net asset value

The question it answers: what is the balance sheet worth after every liability is paid? Net asset value takes the assets — at book value, or better at realisable or replacement value — and deducts the liabilities: the business as a collection of things rather than as a going concern.

• Inputs. The latest balance sheet, with stale fixed-asset values restated, stock and debtors tested for recoverability, and every liability included, not only those on the face of the accounts.
• Strengths. Grounded in things that can be counted and sold, and the floor under every other method: a going-concern value below net assets means the assets are worth more sold than kept.
• Weaknesses. It ignores earnings. A profitable services business with a laptop and a lease has a net asset value near zero and a real value many times that; goodwill, contracts and people appear nowhere.
• Applies when. The business is asset-heavy — property, plant, a fleet, an investment book — loss-making, or being wound down. Otherwise it is a sanity check.
• Common errors. Taking book value as market value for property bought decades ago; forgetting the tax a revaluation would trigger; counting intangibles a buyer would not pay for; and using it as the primary method for a business whose value is its earnings.

Discounted cash flow

The question it answers: what are this business's future cash flows worth today, at a rate that reflects the risk of receiving them? A DCF projects free cash flow for a number of years, adds a terminal value for everything after, and discounts the whole to the present.

• Inputs. A forecast of revenue, margins, tax, capital expenditure and working capital; a discount rate built up from a risk-free rate, an equity risk premium and premia for size and company-specific risk; and a growth rate or exit multiple for the period after.
• Strengths. The only method that values this business's specific future rather than the market's view of businesses like it; it can handle unusual capital needs, a turnaround, or growth a multiple cannot see.
• Weaknesses. Everything depends on the forecast and the discount rate, and the terminal value is usually most of the answer; small changes to the growth or discount assumptions move the result a long way, so a DCF can be built to support any price.
• Applies when. A credible forecast with stated assumptions, and cash flows that differ materially from current earnings. Weak evidence for a stable business whose next five years look like its last five.
• Common errors. Charging tax on EBITDA rather than EBIT, which taxes a cost; adding back depreciation that was never deducted, which counts it twice; Gordon growth on a thin spread between the discount rate and the growth rate, which makes the terminal value very large or infinite; and forgetting that a growing business absorbs working capital.

Seller's discretionary earnings

The question it answers: what is the whole financial benefit an owner-operator takes from this business, and what would the next one pay for it? SDE is EBITDA plus the owner's salary, benefits and personal expenses run through the company, plus genuine one-offs: the business as a job and an income stream together.

• Inputs. Reported profit; interest, tax, depreciation and amortisation; the owner's total compensation and benefits; and a list of non-recurring items with evidence for each.
• Strengths. For a small owner-run business it is how the market actually prices, and it removes the argument about what the owner "should" be paid.
• Weaknesses. It assumes the buyer will do the owner's job; a buyer who must hire a manager is buying a smaller earnings stream. SDE multiples are lower than EBITDA multiples for the same business, and the two are not interchangeable.
• Applies when. The business is small and owner-operated and the buyer will run it. As earnings grow and management deepens, EBITDA takes over.
• Common errors. Applying an EBITDA multiple to an SDE figure; adding back a partner's salary when the partner is staying; and treating expenses the business needs as discretionary. EBITDA vs SDE covers the bridge and the trap.

EBITDA multiple

The question it answers: given what buyers pay for a year of maintainable earnings in businesses like this one, what would they pay for this one's? Enterprise value is normalised EBITDA times a multiple that carries the market's view of sector, size, growth and risk.

• Inputs. Maintainable EBITDA after normalisation for owner costs, one-offs and accounting choices; a sector multiple; and explicit adjustments for size, growth, margin, recurring revenue and customer concentration.
• Strengths. Simple, widely understood, and the language every counterparty speaks; because the mid-market prices on it, the answer can be tested against the market.
• Weaknesses. A multiple carries no information of its own about this business; it is a summary of other businesses. Everything sits in two contested numbers: the EBITDA depends on the adjustments and the multiple on where it came from.
• Applies when. The business is established, profitable and management-run. Weak for a loss-making, early-stage or asset-heavy business, and misleading where the earnings are heavily adjusted.
• Common errors. Taking the seller's adjusted EBITDA at face value; borrowing a multiple from much larger businesses; mixing last-twelve-months earnings with a forecast multiple, or an equity value with an enterprise multiple; and forgetting the bridge to equity value. The EBITDA multiple calculator does the arithmetic both ways.

Comparable transactions

The question it answers: what have buyers actually paid, recently, for businesses like this one? It is the only method whose multiple is observed rather than modelled: completed deals in the same sector and size band are reduced to a multiple and applied to the subject's earnings.

• Inputs. Completed transactions with a disclosed price and earnings figure, in the same sector, of comparable size, within a recent period — and enough of them to draw a median. One deal is an anecdote.
• Strengths. Evidence rather than theory: the prices paid already contain every judgement the modelled methods have to assume, and their spread says how wide the range should be.
• Weaknesses. Good comps are scarce for private deals, disclosed prices are often incomplete, and every deal carried terms — an earn-out, a property, a management roll — the headline multiple does not show. A set from another cycle is not evidence about this one.
• Applies when. You hold a library of relevant deals and can say why each is comparable. Without that it is a rule of thumb with a better name.
• Common errors. Using the mean, so one outsized deal moves the answer; borrowing a multiple from larger businesses; mixing asking with completed prices; and quietly narrowing the sample to the deals that support the price.

Revenue multiples, briefly

A revenue multiple values a business on sales rather than profit. It exists for businesses with no meaningful earnings yet — early-stage, loss-making, or investing ahead of growth — and for a few sectors, subscription software among them, where revenue quality is the better guide. For a profitable private company it is a cross-check at best: two businesses with the same revenue and different margins are not worth the same, and a revenue multiple cannot tell them apart.

The methods compared

Why the methods disagree

They disagree because they look at different things. Net assets do not see earnings. A multiple sees only the market's view of businesses like this one, not this one's future. A DCF sees only the forecast, and inherits every optimism in it. Comps see prices paid, and every private term that was not disclosed. A DCF well above the multiple means the forecast is better than the history and must be believed before it is priced; net assets above every earnings method mean the assets are not earning their keep; comps below the modelled multiple mean the market is paying less for this sector than the table says. Each is a finding, and the wrong response is to average before understanding why.

Blending the methods into a range

A blended figure with a range is more honest than any single method. The weights should follow the business — a statement about which evidence is most relevant here, not a way of averaging away an inconvenient answer. An asset-heavy engineering business weights net assets and the multiple; a software business with a credible forecast weights DCF and comps; a small owner-run business weights SDE. A thin or absent comp set should stand the comps method down rather than contribute a guessed multiple.

The width of the range should reflect how complete the inputs are and how far the methods disagree. Filed accounts, a reconciled management pack and relevant comps support a narrower range than a forecast and a rule of thumb; where real comps exist, the spread of prices actually paid is the best evidence of how wide the range should be. State the weights and the width, because a committee, a client or an investor will ask.

How TrueValue runs all five

TrueValue's M&A valuation software runs all five methods on one set of inputs seeded from the target's extracted accounts, and reports every method's answer beside a blend weighted by sector and by the nature of the business. The arithmetic is deterministic and unit-tested — the DCF charges tax on EBIT, never adds depreciation back, and falls back to an exit multiple when the growth spread is too thin for Gordon growth — and the AI writes the commentary with no path to alter a figure. Comparable transactions come from your own library and stand down where too few relevant deals exist. The same engine runs free at Value My Deal.