What Does Multiple Expansion Mean?
Multiple expansion is a form of arbitrage where a buyer pays an entry valuation multiple that is lower than the exit valuation multiple. Essentially, multiple expansion is the concept of buying low and selling high. The initial investment is at a lower multiple because the company is smaller, has higher risk or a lack of process, but the exit is done at a higher multiple once the value creation strategy over the life of the investment has been executed. Multiple expansion is also referred to as the "multiple effect" or "multiple arbitrage".
Divestopedia Explains Multiple Expansion
The term can be used in reference to any type of buyer, but it is especially common in the context of private equity. Some private equity firms employ leverage, deal structure and multiple expansion to generate a return on their investment. Buying a company for 3X EBITDA and selling it for 4X is an example of a multiple expansion. Although it is difficult to predict multiple expansions at the onset of an acquisition, private equity firms use the following techniques to increase the probabilities of achieving it:
- Follow a disciplined approach to buying companies at lower multiples;
- Drive operational efficiency and free cash flow generation during the life of the investment;
- Constantly monitor current valuation multiples and industry M&A activity; and
- Proactively seek the best timing to exit their investment at the highest multiple.
These are "best in class" value creation techniques that private owners should consider in their own companies well before selling or partnering with a PE firm.