Using "Comparables" to Estimate the Value of your Business

Almost every entrepreneur considering a future sale of the business is interested in knowing what comparable businesses are selling for and what the typical multiple of earnings (EBITDA) are for their industry.  However, there are many variables to consider when comparables are used to estimate enterprise value, many of which can lead to inappropriate assumptions about the value of the business.  While comparable transactions can be one component of a pre-sale valuation, they should always be used along with other valuation techniques.  In the end, the actual multiple a business trades for depends on 1) the prevailing market conditions, 2) the nuances of the business and the industry it participates in, and 3) how the business is marketed and sold.
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The number of direct comparables.  For companies in the lower middle market (Enterprise values of between $10 million and $100 million), there are often very few direct comparables, let alone those with a similar growth or profitability profile.  Typically, data on EBITDA multiples come from databases that extract information from press releases and from disclosures made by publicly traded companies when acquiring private companies.  Under most circumstances, there is no reason for private companies to disclose the purchase price and/or terms of any companies they acquire, let alone any details about the businesses themselves.  Some databases allow companies to extract financial data on a no-names basis in turn for submitting financial M&A transaction data, however, this only helps to guide users with average multiples, the median multiple, and/or ranges of valuations in specific industries/segments.

Timing.  The prevailing market conditions for the general economy and the specific industry in which the company participates are in constant flux.  This means that valuations vary over time based on competitive factors as well as external factors such as the cost of money.  The timing of comparable deals is especially sensitive in cyclical industries.

Size.  In general, larger companies trade at higher multiples so it is important that when researching comparables, companies of similar size are used, or the transaction data is size adjusted. Since much of this data comes from high-profile deals and/or when publicly traded companies are required to disclose transaction details to shareholders, this usually means that the published, or publicly available transaction data is scarce for smaller companies in the lower-middle market.

Location. Some businesses trade at higher multiples simply because of where they are located.  Differences in labour laws, tax incentives and rates, compliance requirements, average wages, skilled labour availability, etc. make it very difficult to make valid comparisons between deals in Europe and Canada/U.S. for instance.

Public vs private.  Publicly traded companies trade at higher multiples, not only because they are typically larger, but also because of the liquidity it provides shareholders.  Shareholder liquidity is usually much more complicated and expensive for investor holdings in private companies.

EBITDA multiples period.  Often when comparable data is available, it is not clear whether the EBITDA multiple is based on the trailing twelve months (TTM), the last fiscal year, or a forward multiple on projections. Some public companies will only report the multiple after synergies to help gain support from analysts and shareholders that they are not overpaying for an acquisition. The standard protocol calls for EBITDA multiples to be based on TTM, but there is nothing requiring anyone to comply with this standard.

EBITDA Adjustments.  It is normal for business buyers and sellers to adjust the TTM EBITDA based on their judgment of maintainable earnings under new ownership.  Normally, there is little if any hard data on what, or if any EBITDA adjustments have been included in a reported EBITDA multiple.

Assumed debt/liabilities.  Most deals are completed on a cash-free/debt-free basis, but that may not always be the case.  If liabilities, such as a Line of Credit, are assumed by the buyer, they may report the price they paid, along with the TTM EBITDA, but it may not be reflective of the Enterprise Value (equity plus debt) as a multiple of EBITDA.

Minority/majority deals.  Generally, investors expect a discount on an investment when only taking a minority position and this may not be fully disclosed.

In conclusion, there are a lot of variables that limit the value of comparable transaction data as the primary means of estimating a company’s enterprise value.  That is not to say it doesn’t provide value – it must simply be used to supplement other valuation techniques.
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There are also a lot of comparable data points that Investment Bankers and M&A Advisors have access to through their experience but are not available to the broader market.  For example, when bidding on a company in a competitive process, buyers and their advisors get a sense of the multiple they need to pay to remain competitive.  On sell-side engagements, M&A professionals are given the opportunity to observe bids from multiple buyers, giving them a much deeper appreciation of expected trading multiples in a given industry.  This insight is much more valuable than any database that reports on EBITDA multiples, as the nuances of the business and the industry are understood.

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