When in doubt about how to proceed look at what your neighbour has been doing. In valuation this means estimating the value of your company by comparing it with similar businesses that have been sold recently.
The theory behind the comparable transactions method is quite simple:
– select comparable transactions;
– calculate multiples (a multiple is a ratio that is derived by dividing the market value of an asset by a specific item on the financial statements or by another metric);
– apply multiples to the metrics of your company to estimate its value.
For mature companies the most commonly used multiples are price-to-earnings and enterprise value-to-ebitda. For startups and high growth businesses revenue might offer a better alternative:
– revenue is less distorted by other assumptions;
– it usually come first, long before the profitability is achieved;
– easier to compare across geographies with different legislation and taxation rules.
In addition, you can calculate the so called “esoteric multiples”. Those are non-financial metrics that should demonstrate the level of engagement the company has been able to generate. You will not find them on either the balance sheet, or on the income statement. The esoteric multiples can be derived by using different performance metrics, depending on the nature of business, like, number of users, followers, downloads, repeat users, customers, paying customers, repeat customers and similar.
Let’s take a simplified example. You want to estimate value of a SaaS startup which has generated EUR 1 million in revenue over the last 12 months and has signed up 1,000 paying customers. A company operating in a different niche but having basically the same business model has recently been sold for EUR 10 million. The press release announcing the transaction says that the company’s revenue before the deal had reached EUR 4 million and that its number of customers was 5,000.
Based one this information you can calculate that the transaction price paid valued this company at 2.5x its revenue. You can also derive the value assigned to each customer by dividing the sales price by number of customers, which gives you EUR 200.
Applying these multiples to your company revenue you arrive at EUR 2.5 million based on revenue and at EUR 2 million based on the number of customers. This provides a reasonable value range for the business which can be used for further analysis or in negotiations.
The use of comparable transactions method offers certain benefits:
– it is truly market-based because the multiples are derived from transactions involving strategic buyers;
– as a method it is easy to understand and to use;
– for those not very comfortable with numbers there is practically no hard math involved.
On the flip side, though:
– there is fairly limited information on private market transactions available in public domain to base your analysis upon;
– depending on the stage of development of the company that you are valuing there might be a very limited number of “hard” metrics to be used.
To conclude, the comparable transactions method can be used for startup valuation but there are a few things to remember:
– lack of comparable transaction information is likely to make the results not very robust. In most cases you will have to rely on a very limited number of transactions you can find details about.
– there are no two companies that are absolutely identical. The level of comparability quite often is a matter of judgement.
– comparable transactions valuation is probably better when used for cross-check purposes with the results obtained by applying other methods
– the process itself can lead to better understanding of your company’s business model and pinpoint the truly important metrics to look at.
Mark Twain has once said that comparison is the death of joy. It should not necessarily be so.
This note was first published on Medium.com on 6 November 2023.
