Exit Multiple

What is an exit multiple?

Exit multiple (German: Exit-Multiplikator, Ausstiegsmultiplikator) denotes the multiple at which a company is expected to be valued at a future point in time, usually on a sale or at the end of a planning period. Applied to a metric at that point in time, such as revenue or EBITDA (earnings before interest, taxes, depreciation and amortisation), it gives the expected company value at exit (enterprise value). This is the value of the business before deduction of debt. An exit multiple of 7 applied to an expected EBITDA of EUR 5 million, for example, gives an enterprise value of EUR 35 million on a sale.

Formula: enterprise value at exit or at the end of planning = EBITDA or revenue at that point in time × exit multiple

The term has three fields of application. In DCF valuation, it is used to calculate the terminal value, that is, the value of all years after the planning period. In the venture capital method, it determines the expected sale value from which investors derive today's valuation. In the calculation models of financial investors (private equity), it is set against the entry multiple at which they bought the company. It is recorded in the financial model, in a fund's investment committee paper or in the valuation report. In colloquial usage, “exit multiple” is occasionally also used for the multiple an investor achieves on its invested capital. That is a different measure, distinguished below.

Exit multiple method and perpetuity in the DCF

Instead of calculating the terminal value as a perpetuity, it can be set as a multiple of a metric of the last plan year, usually EBITDA. This method is widespread among banks and financial investors because it ties in with observable market prices. It has a price, however: a method that is meant to derive the value from the company's own plan adopts a market valuation for the largest share of the value.

The exit multiple is therefore checked against the perpetuity. From the terminal value, cost of capital and the free cash flow of the following year, the permanent growth rate that the multiple implies can be calculated. The formula results from rearranging the Gordon formula of the perpetuity: growth rate = cost of capital minus (free cash flow of the following year ÷ terminal value). If this rate lies well above the long-term achievable growth, the multiple has been chosen too high. If EBITDA in the last plan year is, for example, EUR 3.0 million and the multiple is 8, the terminal value is EUR 24 million. With a cash flow of the following year of EUR 1.5 million and cost of capital of 10%, this implies a permanent growth rate of 10% minus 6.25% = 3.75%.

The exit multiple in the venture capital method

In venture capital, young companies are often valued from the expected sale. The venture capital method proceeds in five steps:

1. Estimate a metric at the planned exit, usually revenue or EBITDA in 5 to 7 years.
2. Multiply by an exit multiple to give the expected value on sale.
3. Discount at the investor's target return (discount rate) or divide by the target multiple, that is, the multiple it wants to achieve on its invested capital.
4. Take into account the dilution from later funding rounds, which reduces the investor's share until the sale.
5. Derive the valuation after the payment (post-money valuation) and before the payment (pre-money valuation) from the share the investor demands today for its capital.

The method is simple but sensitive. The exit multiple feeds directly into today's valuation: an assumption lower by a quarter reduces the exit value and the permissible post-money valuation by a quarter. Because only the success case is considered, the high target return also covers the risk of failure.

Entry and exit for financial investors

Financial investors who acquire majority stakes break down their expected return into three sources. These are the growth of EBITDA, the repayment of acquisition debt from ongoing cash flow and the change in the multiple between entry and exit. An exit at a higher multiple than at entry is called multiple expansion; the opposite case is multiple contraction.

Cautious models often set the exit multiple no higher than the entry multiple, so that the return does not depend on a favourable market phase. For sellers, this calculation explains up to what price a financial investor can go today. The more cautious its assumption for the exit, the lower its offer for the entry.

Derivation and plausibility check

An exit multiple is derived from today's multiples but adjusted to the profile the company is expected to have at exit. A company that is growing strongly today and is valued at a high revenue multiple will probably grow more slowly in seven years and will then rather be valued on its earnings. Transactions (precedent transactions) and stock market values of more mature companies with the expected later profile therefore serve as the yardstick.

Added to this is the market cycle. Multiples observed in a phase of low interest rates and high valuations are particularly uncertain as an assumption for a sale in several years. Robust models therefore work with a range and show its effect on the result openly.

Worked example: exit multiple in the venture capital method

An investor is considering an investment of EUR 4 million in a software company. The plan expects revenue of EUR 20 million in five years. As the exit multiple, the investor hypothetically assumes 4.0 times revenue, as its target multiple 5.0 times its capital. Net financial debt and preferential rights on sale are disregarded.

• Exit value: EUR 20 million × 4.0 = EUR 80 million
• Target multiple of 5.0 over five years: corresponds to around 38% per year, since 1.38⁵ ≈ 5.0
• Required proceeds at exit: EUR 4 million × 5.0 = EUR 20 million
• Required share at exit: 20 ÷ 80 = 25%
• Expected dilution from later rounds: the investor retains 75% of its share; required share today: 25% ÷ 0.75 = 33.3%
• Post-money valuation today: EUR 4 million ÷ 33.3% = EUR 12 million; pre-money valuation: 12 minus 4 = EUR 8 million
• Exit multiple 3.0 instead of 4.0: exit value EUR 60 million; share at exit 20 ÷ 60 = 33.3%; share today 33.3% ÷ 0.75 = 44.4%
• Thus post-money 4 ÷ 44.4% = EUR 9 million and pre-money EUR 5 million

An exit multiple lower by one reduces the pre-money valuation in this example from EUR 8 million to EUR 5 million, that is, by 37.5%. The pre-money valuation reacts more strongly than the exit value because the investment amount stays fixed and the entire adjustment is borne by the value of the existing shares.

Distinctions: exit multiple, MOIC, terminal value and IRR

• Multiple on invested capital (MOIC): the multiple on invested capital relates an investor's returns to its outlay. A value of 1.0 means the invested capital has flowed back without gain or loss. It describes the investor's return, whereas the exit multiple describes the valuation of the company.
• EBITDA multiple: the multiple at which comparable companies are valued today. The exit multiple transfers this logic to a future point in time.
• Terminal value: the value of all cash flows after the planning period. The exit multiple is one of two methods of calculating it, the perpetuity the other.
• Internal rate of return (IRR): the annual return on an investment. Unlike a multiple, it takes into account how long the capital was tied up.

Common mistakes

• Today's growth multiple for the exit. A mature company in seven years will not be valued at the multiple it receives today as a fast-growing company.
• Expansion without justification. An exit multiple above the entry multiple makes the return depend on a favourable market phase and should be justified separately.
• Dilution forgotten. Later funding rounds reduce the investor's share. Anyone who does not factor them in overestimates the permissible valuation today.
• Enterprise value at exit equated with proceeds. Financial debt is deducted from the exit value, and liquidation preferences distribute the proceeds unequally among the shareholders.
• Only one scenario. A single exit value conceals how strongly the valuation depends on this assumption. A range with several multiples makes it visible.

Frequently asked questions

Is the exit multiple the same as the multiple an investor achieves?

No. The exit multiple values the company, for example as a multiple of its EBITDA on a sale. The multiple on invested capital measures how much an investor gets back relative to its outlay. The two are connected, because a higher exit value also brings higher returns, but they are different measures.

What is the difference between the exit multiple method and the perpetuity?

The origin of the terminal value. The perpetuity extends the free cash flow with a permanent growth rate and stays with the company's own plan. The exit multiple method sets a market price, usually a multiple of EBITDA. If both are calculated, the comparison shows which permanent growth rate is embedded in the multiple.

Which exit multiple should a financial model assume?

A cautious, well-founded one. Derivation from current multiples of more mature comparable companies is customary, often not above the level at which the company would be valued today. The effect of deviating assumptions belongs in the model as a range.

Why do venture investors calculate with target multiples rather than interest rates?

Because the holding period is hard to predict and a multiple is easier to compare. The two can be converted into each other. A fivefold return in five years corresponds to around 38% per year, the same fivefold return in eight years to only around 22% per year.

How does dilution from later rounds have an effect?

It increases the share that an investor demands today. If it expects later rounds to reduce its share by a quarter, it must receive a third more share today to reach its target share on the sale.

The Roemer Capital view

In funding rounds from Series A to C, we recalculate the venture capital method from the investors' perspective before talks begin. This way founders see which exit value must stand behind a valuation expectation and can justify it with possible buyer groups and current transaction multiples for the expected later profile.

In a sale process, we go the opposite way. We estimate which exit assumptions a financial investor is working with and derive from that which price it can present today. This helps to assess offers from financial investors and strategic acquirers side by side.