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.
Disclaimer: The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. All content relates to the current financial year only. Future changes to tax laws, thresholds or administrative requirements may affect the accuracy or relevance of this information, so you should always confirm that the guidance remains current. While every effort has been made to ensure accuracy at the time of publication, Dolman Bateman accepts no responsibility or liability for any loss or damage arising from reliance on this information. You should seek professional advice tailored to your circumstances before making any financial or tax decision.
