Exit Multiple Definition
The actual exit multiple simply refers to the return of investment. If an investor is investing $100 and sells his investment in the future for $300, this is an exit multiple of 3x.
Exit multiples are often used for valuations. For example, if the standard EV / Revenue multiple for a sector is 3x and you have a 5 year financial projection model, you can estimate the value of the company in each of those 5 years using revenue projections and the 3x EV / Revenue multiple.
In a discounted cash flow using the terminal value methodology, exit multiples are used to obtain a terminal value for the company. Please see the discounted cash flow definitions for more detail.
The concept of an exit multiple is similar to that of an internal rate of return (IRR) and one can be used to calculate the other. Assume that an investment of $100 is made in Year 1 and the investor wants to achieve a 3x exit multiple in 5 years time. In order to achieve this, his investment must grow by a certain rate each year. The formula for this will be familiar to any mathematics or finance student,
- 300 = 100 x (1+n)^5
where n is the growth rate required in the investment. In this scenario the answer is around 25%.
To calculate in reverse, assume we invest $500 into a company which we know will provide 10% compound return each year for a 10 year period. The total return is now 500 x (1+10%)^10 = $1296 which is an exit multiple of roughly 2.6x