Businesses are valued in a number of different ways; discounted cash flows, net tangible assets, and cost of creation, to name but a few. The methodology most often applied however, is the capitalisation of future maintainable earnings (CFME)... and with it comes the often-misunderstood capitalisation rate, usually applied as a multiple.
 
Much like the Continuum Transfunctioner (as immortalised in the, some would say 'ground-breaking' movie "Dude, Where's My Car?"), when it comes to the multiple applied in CFME valuations, "...its power is only exceeded by its mystery". Many business owners regularly assume that the multiple should always and forevermore be 3, but rarely is this the case... the multiple is simply a misunderstood beast.

When valuing a business, it is generally accepted (by us valuation boffins) that the discounted cash flow (DCF) method is the most accurate and reliable. In general terms, the DCF method calculates what all of the future income streams of a business are worth in 'today's money' if received at the date of the valuation as a lump sum. This is done (in its most simplified form) by determining firstly, how long we can reliably measure those income streams into the future (usually in years), and secondly, determining what sort of discount rate to apply based upon the time-value of money and the relative risk of the business. The reason that this method is not the most regularly utilised by valuation professionals is that most SMEs don’t have cash-flow forecasts for the next 3 months, let alone the next 5 years... so what do we do instead?
Enter the CFME valuation methodology. As long as the business/entity has been profitable for the last few years (and thus giving us some comfort that the business will remain profitable into the future), we can apply this methodology as a proxy for the DCF valuation. Instead of discounting each parcel of cash that the business is likely to receive into the future back to today's value, the CFME methodology seeks to determine an approximation of the profits that the business/entity is likely to make into the future (usually by reference to profitability in the form of net profit, before tax and excluding interest in prior years), and then applying the multiple. The multiple represents a risk assessment of and for the business; it considers the industry, the turnover level, the relative financial performance of the business, insurance and credit risk, specific commercial risks, entity-specific risks, reliance upon key employees, owners or key customers, geographic risks, competitor risks, technology considerations... to name but a few. It is not simply 3*.
For instance, in micro businesses (where turnover is less than $500,000), it is not unusual for the multiple to be less than 1, as the business depends entirely on a single individual. Essentially, the business sale would be a person purchasing a job.
A business turning over less than $1 million is often traded for a multiple of between 1.5 and 2.5. It would need to be a business possessing some very special attributes in order to attract a multiple of 3 or more. Equally, a business in the turnover range of $1 million to $5 million would have to be quite special or be purchased for synergistic benefits to attract a multiple of 3 or more.
Once a business turns over more than $5 million, making a significant (and relatively consistent) profit, with few operational risks, it is more likely (but by no means guaranteed) that the business valuation CFME multiple will approach or eclipse the mystical number 3.
Like any specialist service, business valuation requires the systematic application of academic rigour within the context of sensible, commercial considerations. A one-size-fits-all approach is not only inappropriate; it can be misleading and potentially damaging.

* Occasionally, through pure happenstance, the multiple might just happen to be 3... by accident.