PE Multiples in Valuing Small Businesses

We recently had a conversation with a business owner convinced that his business, generating $1 million in profit before interest and tax (EBIT), was worth $20 million. Why? Because companies in his industry listed on the ASX were trading at a Price to Earnings (PE) ratio of 20.

It’s a common misunderstanding, but a costly one.

What is the PE Multiple vs the EBIT Multiple?

The PE ratio reflects the multiple of net profit after tax (NPAT) investors are willing to pay for a business. It’s after interest and tax, so it includes the cost of debt.

EBIT multiples, by contrast, are based on earnings before interest and tax—essentially, the business’s operating performance, not influenced by how it’s financed.

So if you’re using a PE ratio from a publicly listed company to value your own private business based on EBIT, you’re not comparing apples with apples.

From PE to EBIT: How the Numbers Stack Up

Let’s break it down using a real-world example:

• Public Company Value: $2 billion

• NPAT: $100 million

• PE Multiple: 20 (i.e. $2 billion ÷ $100 million)

• Debt: $2 billion at 7% interest

• Tax rate: 30%

We reverse engineer:

• Profit before tax: $142 million

• EBIT (add $140 million interest): $282 million

• EBIT multiple = $2 billion ÷ $282 million = 7

So that PE multiple of 20 becomes an EBIT multiple of 7.

Why You Can’t Apply Public Company Multiples to Small Businesses

Here’s where most business owners go wrong. You can’t just apply the same multiple. There are two major discounts that apply to small, privately owned businesses:

1. Size Premium

Smaller companies are riskier: fewer customers, less access to capital, limited management depth. Public markets recognise this with lower multiples. Even small-cap listed companies can see discounts of up to 20% compared to industry giants.

2. Marketability (Liquidity) Discount

Shares in a listed company can be sold within minutes. Selling a stake in a private company? That can take months, even years. The lack of liquidity justifies a 35%–50% discount on value.

Applying Discounts to Get a Realistic EBIT Multiple

Factor	Calculation
Public EBIT Multiple	7
Size Premium (20%)	7 – 1.4 = 5.6
Marketability Discount (40%)	5.6 – 2.2 = 3.4

Your $1 million EBIT business, valued at a 3.4x multiple, would be worth $3.4 million, not $20 million.

But What If a Buyer Wants Control?

Technically, PE ratios reflect the value of a minority interest. If someone wants to acquire a controlling stake, a control premium may apply—usually 20% to 35%. That pushes the multiple up to 4.1–4.6x EBIT, bringing value closer to $4.1M–$4.6M.

Get Real with Business Valuation

Valuation isn’t about hope or headlines—it’s about sound financial principles. Don’t fall into the trap of applying listed company PE multiples to your private business without adjusting for scale and liquidity.

At Dolman Bateman, we help owners understand the real value of their business, so they can make confident, informed decisions.

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Disclaimer:

The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.