What This Analysis Delivers
- A framework for deriving exit multiples from long-run growth, return, and discount rate assumptions embedded in discounted cash flow (DCF) models.
- Empirical evidence that expected growth explains much of the variation in observed multiples for high-growth firms.
- Recognition that interest rate regimes materially influence valuation levels and should be reflected in exit assumptions.
In high-growth company valuations, terminal (exit) assumptions often account for a large share of enterprise value. When exit multiples are selected without explicit reference to growth, return, and rate expectations, the analysis can become internally inconsistent. The framework that follows draws on valuation theory and empirical evidence to show how exit multiples can be derived from and reconciled with underlying economic assumptions.
The Limits of the Five-Year Forecast
A standard income approach using a five-year explicit forecast plus a Gordon growth terminal value assumes the company reaches “stable growth” by year five. For many smaller, early-stage growth firms, that is unrealistic. The high-growth period may extend well beyond five years. One solution is to use two-stage or three-stage (or H-model) structures. However, in practice, many companies’ business plans stop at year five, and forecasting an additional five years is often too difficult.
Consequently, many valuers use a terminal (exit) multiple based on EBITDA or revenue. This approach is market-consistent but blends relative valuation with an income-based framework.
Yes, we know this is not ideal. Mixing approaches is theoretically flawed, but it remains common practice, especially in the private equity world.
The Value-Driver Identity as a Bridge
A useful bridge is the value-driver identity, which links terminal value to ROIC, growth, and the discount rate. In enterprise terms:
Divide by EBIT (or revenue) to get an implied EV/EBIT (or EV/Revenue) multiple that is consistent with the company’s long-run economics.
These are approximations, but they tie the exit multiple to the assumptions about long-run growth (g), WACC, ROIC, margins and taxes.
Valuers should then cross-check their exit multiple assumption against current medians, long-run sector bands, and transaction evidence. If comps diverge, valuers can explain why; differences in growth durability, capital intensity, or risk.
In reality, the selection of the multiple is based on the median or average of current valuations at the time of the analysis, or the average of the median over the last five to 10 years. But is this correct?
Well, as always—it depends. It could be. Data teaches us something important that we should incorporate into our thinking when selecting the exit multiple.
For exit EBITDA multiples, Michael Mauboussin found that expected EBITDA growth and the spread between ROIC and WACC have a significant impact on valuation for unprofitable companies. However, determining ROIC or exit EBITDA margin is difficult when companies are not yet profitable or in a stable phase.
For this reason, revenue growth and gross margin are often used instead.
What the Data Show
To further investigate this relationship, we examined listed operating firms across all industries in the US, Canada, and Europe, selecting only those with a 10-year CAGR above 30%, which we use as a proxy for growth-stage companies. The analysis covers the period between 2015 and 2024. For each year, we ran a regression with the LTM EV/Revenue multiple as the dependent variable and the 1-year expected revenue growth rate as the independent variable (adding ROIC or gross profit margin as a second independent variable in the regressions did not prove to be statistically significant, as expected, given that those companies are not yet in the stable stage).
We observed two key insights:
- Expected one-year growth explains around 55% of the variation in valuation multiples.
- The intercept of each year’s regression is negatively correlated with the corresponding risk-free rate. This is intuitive, as high-growth companies’ cash flows (i.e. value) are concentrated in the future, making their valuations more sensitive to the risk-free rate.
Authors’ analysis
The second point highlights another important consideration when selecting an exit multiple: it is maybe necessary to form a view on the level of the risk-free rate at the time of exit. The prevailing interest rate environment will influence whether the assumed multiple is realistic and can be supported.
Conclusion
Based on both data and experience, investors, analysts, and valuation specialists should avoid simply applying a median multiple in the exit terminal year. Instead, they should consider expected growth beyond the terminal year and form a view on the likely level of the risk-free rate. Everyone would love to return to the low rates of 2020–2021 with sky-high valuations, but that’s unlikely. Using the average of the last five or 10 years may incorporate valuations that are too high for today’s environment.
Three Practitioner Takeaways
- Exit multiples are not plug numbers. They reflect assumptions about long-run growth, returns on capital, and the cost of capital embedded in the DCF.
- Growth expectations largely determine valuation differences. In high-growth companies, higher expected revenue growth supports higher observed multiples.
- Interest rates matter. The level of the risk-free rate materially influences valuation levels and should be considered when selecting an exit multiple.