When it comes to valuing a private business using market-based methods, one valuation multiple that stands out is the price to business revenues. Actually, there are two variants of this distinguished valuation tool:
- Price to gross revenue
- Price to net sales
In fact, there are a number of industry sectors where the price to sales valuation multiples are preferred. Here are the top ones:
- Professional practices, especially medical and dental practices
- Technology companies in high growth mode
- Manufacturing businesses, especially those in emerging market segments
With so many valuation multiples to choose from, why would business people and professional appraisers trust price to sales numbers more? Because in some situations this measure of business value is more reliable. Here are some scenarios when you may want to consider using the business revenues as the key basis to appraise a company:
Professional practice value is about client retention
Client retention is essential to preserve the value of a professional practice that is being sold. Essentially, the practice buyer is after the revenue stream of the practice and may have plans regarding profitability improvement or capital investments. Hence, the valuation multiples based on profits, say the practice net income or EBITDA, as less valuable when estimating what the practice is worth.
High growth company value depends on sales growth
Young growing companies can become very attractive if they manage to establish themselves as a leader in a market niche. Their ability to generate revenues in a highly promising industry sector is the major value driver. In this sense, the company’s revenue is a strong predictor of its success – that sheds light on how valuable the firm is.
At the same time, such companies may not yet have been optimized for top profitability. In addition, further business expansion may call for considerable capital investment. So, again, using valuation multiples based on profitability or current asset base is not as revealing.
Business value is driven by market share and revenue growth
The same argument holds for established manufacturing businesses that are successful in a new market sector. Imagine a company that has developed a strong customer following in one of the green industry segments.
Early entrants with a compelling product and service mix tend to grab market share and generate sales quickly. You can capture this key value driver by using the price to revenue valuation multiples when appraising such a company.
Income valuation methods to supplement your business appraisal
To round out your business valuation, do not forget to take advantage of other methods, especially those under the income approach. The Discounted Cash Flow method in particular is an excellent supplement to value a business based on earnings forecast and risk going forward.
Such expectation driven business appraisal is a powerful way to verify the business value estimates you get from the market-based valuation multiples.