Exit Multiple
The exit multiple allows investors to understand how much of a return they could receive based on the value of a startup at exit. Investors can use this post-money valuation at exit to decide the risk of their investment. This article will cover the exit multiple definition, purpose, and calculation methods.
What is an Exit Multiple?
The best way to understand what the exit multiple is involves looking at the calculations investors use. When an investor needs to understand the potential return they could yield from their startup investment, they calculate the exit multiple, which is the multiple for the number of times they will receive back their investment, using the following calculation:
Exit multiple = Sales Price ÷ Financial Metric (commonly revenue or EBITDA)
A simple example of how the above calculation works in practice is that when a company sells for $100M with $20M EBITDA = 5x Exit Multiple, meaning the investor receives five times what they originally invested, making it a financially worthwhile endeavour.
This multiple is essential for investors to consider because it represents the value they place on the company at exit. Its role is to measure return potential relative to initial investment to ensure investors get a healthy return on their initial investment, especially if shares decrease in value during a down round.
Purpose of Exit Multiple in Venture Capital
The purpose of the exit multiple in venture capital is to calculate how much the potential return will be when an investor exits and the startup sells. It allows investors to compare deals and ensure they achieve the best return, and avoid ownership dilution.
Without exit multiples, it would be impossible for investors to measure the likelihood of receiving their investment back and how much profit they might receive at exit. Exit multiples provide a standardized measure, allowing investors to compare valuations across industries and company sizes, highlighting relative performance, growth potential, and profitability in different market contexts.
Common Methods for Calculating Exit Multiples
The exit multiple is critical to acquiring investors, so it’s in the interests of startups to calculate it honestly and fairly.
The most common method that investment bankers and private equity firms use to calculate an exit multiple is:
Enterprise Value ÷ EBITDA, Enterprise Value ÷ Revenue
For example:
- Enterprise Value (EV): $150 million
- EBITDA: $25 million
- Revenue: $60 million
Enterprise Value ÷ EBITDA
= $150 million ÷ $25 million
= 6x EV/EBITDA multiple
Enterprise Value ÷ Revenue
= $150 million ÷ $60 million
= 2.5x EV/Revenue multiple
Investors often easily mix up two terms here: equity value multiples and enterprise value multiples. The key difference is that equity value multiples focus on shareholder returns, while enterprise value multiples account for debt and cash, reflecting total business valuation.
It’s also essential to note the different valuation methods for different types of companies. Manufacturing firms, for example, receive valuations based on EBITDA, whereas a SaaS company will be valued on revenue multiples, as they are different forms of companies with different revenue and growth projections.
Investors must ensure that accurate valuations have taken place so their investment is based on accurate and appropriate calculations, so their expectations for a return are accurate, and they have the data to make the best decisions for their financial future.