Demystifying Exit Multiples in the Income Approach: A Practical Guide

When valuing a company using the income approach, the exit multiple plays a critical role in determining terminal value. But this is far from a plug-and-play metric. The choice of exit multiple can make or break a valuation, and getting it right requires a blend of market benchmarking, analytical reasoning, and practical judgment.

Chose An Exit Multiple: Forward vs Backward-Looking Multiples

First, one needs to determine the basis for the exit multiple: Forward-looking multiples shouldn't be your first choice, because they account for future expectations and the time value of money, which are already incorporated in the DCF discounting process; therefore there is risk of double-counting. Instead, the preferred choice to base the exit multiples on are backward-looking multiples, e.g. LTM EBITDA multiples or LTM Revenue multiples etc.

Correct Way of Benchmarking

Often the valuation preparer uses the median multiple of the comparables set and applies this median multiples to the project company. Choosing the median can be the correct answer, but one should benchmark the project company properly against the comps set to determine the correct multiple selection.

In the above example, benchmarking the project company to the median actually seems reasonable based on the following:

• The EBITDA margin benchmarks against the median.

• The revenue growth is at the max, but historically is more in line with the median.

• The revenue base of the project company of JPY18,565m is rather low compared to the comps.

Trading Comps: A Primary Source

Trading comparables are a great way to source multiples. From the above disucssion we have determined that 1) LTM multiple are our preferred choice of exit multiples and 2) in our example we benchmarked the project company against the median. Based on that we determine that a 9.43x LTM EBITDA multiple might be reasonable.

Transaction Comps: A Secondary Check

Transaction multiples can be a useful reference, but they often lack the granularity to assess how comparable the acquired companies are, e.g. often we do not have excess to the financials to compare our project company's financials to. If that’s the case, using trading comps as a benchmark to validate transaction multiples (and vice versa) makes sense. In the below example, we benchmark our project company to the median again, which results in a LTM EBITDA multiple of 9.93x.

Conclusion

Based on our above assessment, the trading comps suggest using a LTM EBITDA exit multiple of 9.43x and the transaction comps indicate 9.93x. Both results are fairly close to each other. Therefore, a defendable LTM EBITDA exit multiple around 9.00-10.00x seems not unreasonable. Read our next article to sense check the reasonableness of the exit multiple in your DCF / Income Approach by calculating the terminal growth rate implied by your exit multiple.