Logic behind using different valuation methods for small/big private companies

CFA Level II Equities
#1

Hi everyone,

My doubt is: In the Wiley study text, it says that under the ‘Market’ approach to valuing private companies, a multiple of EBIT or EBITDA is more appropriate for valuing larger private companies, and a multiple of Net Income is more appropriate for valuing smaller private companies. It goes further to state that for even smaller private companies, a multiple of Revenue may be more appropriate.

Can anyone tell me the logic of using different multiples for different sizes of private companies?

Warm regards!

#2

According to the CFAI, its mainly due to the lack of data for smaller private companies. Here is a paragraph from the book.

“For many very small private companies with limited asset bases, net income based multiples may be more commonly used than EBITDA multiples. For extremely small companies, multiples of revenue may even be commonly applied. This convention considers the likely absence of meaningful financial data and the greater impact and subjectivity associated with such items as owner compensation.”