I've heard that companies in my industry sell for 5 times EBITDA (or any other "rule of thumb").  Isn't that my company's value?  Why shouldn't I just apply a rule of thumb?

Rules of thumb are not recommended and should be used with extreme caution.  Despite the industry that a company may operate in, every company is different and therefore each company will have its own value.  When it comes to selling the company that you've put years, if not decades, into growing and turning it into what it is today, it would be a shame to sell yourself short by doing a quick and dirty rule of thumb application.

A company along with its historical financial results and future expectations should be thoroughly studied.  Only then can a proper determination of value be made.  Rules of thumb are short-cuts to value determination based on standard industry relationships between revenue, profit, equity and value.  Slight differences between the industry standards and your company's profit margins, expected future growth, leveraging ability and numerous other issues can render the industry rule of thumb meaningless.

Think of this example.  Two companies in the same industry both have $500,000 in annual EBITDA.  According to the 5 times EBITDA rule of thumb, they would both be worth $2,500,000.  However, one company has old equipment that needs replacement soon, has a few large customers that are on the brink of bankruptcy and has profit margins that have been slipping below industry standards.  The other company has a significant amount of brand-new equipment, a strong and diverse customer base and is becoming more efficient and reporting higher profit margins each year.  Clearly, these companies are not both worth the same amount and a thorough valuation would identify these issues and their impact on value. 

Now, this example is somewhat facetious - you would obviously pick up on such significant problems as the first company has in the example.  However, there are many more subtle issues that can arise that only a properly trained and well experienced CBV can identify. 

It follows that rules of thumb should only be used as a test of reasonableness for a proper valuation approach.  Any other reliance on rules of thumb can be very risky when buying or selling a business, enacting estate freezes or any other reason where your money is at stake. 

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