What Do Comparables Really Mean?

[Ian Shanno]

One way we value privately held businesses is to look at companies considered comparable, meaning they operate in the same industry, generating revenue in a manner considered competitive to other companies in the space. But how similar are two competitors after all, and how can we quantify their similarities, differences and potential for success in the future by comparing valuations that were actually realized in M&A transactions?

Aren’t valuations subjective, as seen in the eyes of the hungriest buyer willing to take a chance and acquire what they believe is a good shot at future returns? Are M&A transactions always closed by the highest bidder? How frequently does one buyer continue to pay up? Is it common for a buyer to stay in the market or to put their acquisition appetite on hold after closing a deal in order to implement the integration process?

What do comparables really tell us about the potential valuation for privately held businesses considering a sale? Does the last deal done in a given industry really lay the basis for the value of the next one?

[ALIGNMT]

We rely on comparables as a point of reference in ascertaining reasonable, achievable value expectations in the market. The reality is that value is in the eye of the beholder; its purely subjective. Valuation of a company is the buyer/investor’s view that a company’s management team has built unique, defensible assets – tangible or intangible – that provide it a unique opportunity to generate sustainable revenue growth and quality of earnings well into the future.

In one respect the comparable associated with this company’s valuation equates to something like the number of years the buyer/investor has confidence the company will continue to deliver the earnings line (EBITDA, Net Income, etc.) each year. For example, if a company is generating $1 million in EBITDA this year and has defensible value, it may command a six multiple, implying enterprise value of $6 million.

How do we qualify this? Look at meaningful, competitive businesses to the subject company and verify the comparable valuations. Public companies will reflect premiums due to liquidity, critical mass, etc. which must be discounted, and recent M&A transactions can provide interesting perspective on trends in pricing.

Trends are very important, because past performance doesn’t influence future outcomes.

[Author]

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