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Entry Multiple

The price paid for a company as a function of a financial metric

What is Entry Multiple?

An entry multiple, commonly used in leveraged buyouts, refers to the price paid for a company as a function of a financial metric. The entry multiple is crucial for private equity firms to know as it determines the purchase price of a company relative to a financial metric. It is ideal to purchase companies at a low entry multiple.

 

Quick Summary:

  • An entry multiple refers to the price paid for a company as a function of a financial metric.
  • A common multiple used for an entry multiple is EV/EBITDA
  • An entry multiple is commonly used to compare to an exit multiple.

 

Understanding Multiples

A multiple, also known as a multiplier, is a valuation technique that calculates the value of a business relative to a financial metric. Multiples are used to compare businesses operating in similar environments to determine whether a company is reasonably priced compared to peers. There are numerous types of multiples that can be used, including EV/EBITDA, EV/Sales, EV/EBIT, EV/UFCF, and P/E multiples.

For example, if two companies operating in the same industry with similar business operations trade at a P/E multiple of 10x and 4x respectively, ignoring other factors, the company with a 4x P/E multiple is deemed undervalued to investors.

 

Understanding Entry Multiple

Private equity firms use multiples to understand the price that they are paying for a company relative to a financial metric. For example, when a private equity firm is looking to purchase a company, they would want to compare the purchase price of the company relative to a financial metric – it is termed the “entry multiple.”

The most commonly used multiple for an entry multiple is EV/EBITDA. EV is called enterprise value and is the purchase price of a company. EBITDA is the earnings of a company before interest, taxes, depreciation, and amortization and is the company’s operating income.

 

Example of Entry Multiple

A private equity firm is looking to generate a 25% IRR in a leveraged buyout of a company. The firm must pay $500,000 to purchase the company. The income statement of the company is as follows:

 

Entry Multiple - Sample Income Statement

 

Using the EV/EBITDA multiple, what is the implied entry multiple of this company?

The implied entry multiple of this company is $500,000/$123,108 = 4.06x.

 

Relating Entry Multiple and Exit Multiple

An entry multiple is commonly used to compare to an exit multiple. Understanding that an entry multiple is the price paid for a company relative to a financial metric, an exit multiple is simply the sale price of a company relative to a financial metric.

 

Multiple Expansion

For private equity firms, it is desirable to achieve a low entry multiple and a high exit multiple. Essentially, it means that the firm is purchasing the company at a low price relative to a financial metric and selling the company at a higher price relative to a financial metric.

For example, if a firm purchases a company at a purchase price of $100M with an EBITDA of $10M and sells the company five years later at a sale price of $200M with an EBITDA of $15M, the entry multiple is 10x (100M/10M), and the exit multiple is 13.3x (200M/15).

 

Stable Multiple

When the entry multiple is the same as the exit multiple, it means that the firm is purchasing and selling the company at the same relative value. In leveraged buyout models, a stable multiple is assumed.

For example, if a firm purchases a company at a purchase price of $100M with an EBITDA of $10M and sells the company five years later at a sale price of $200M with an EBITDA of $20M, the entry multiple is 10x (100M/10M), and the exit multiple is 10x (200M/20).

 

Multiple Compression

When the entry multiple is higher than the exit multiple, it means that the firm is purchasing the company at a higher price relative to a financial metric and is selling the company at a lower price relative to a financial metric. It is undesirable and compromises the IRR of the investment.

For example, if a firm purchases a company at a purchase price of $100M with an EBITDA of $10M and sells the company five years later at a sale price of $100M with an EBITDA of $20M, the entry multiple is 10x (100M/10M), and the exit multiple is 5x (100M/20).

 

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Enterprise Value vs Equity Value
  • Internal Rate of Return (IRR)
  • Profitability Ratios
  • Types of Valuation Multiples

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