Are Public Company Valuations Relevant to the Value of Your Private Company?

Our recent book, How To SELL Your Business focuses on the sale of private businesses. So, you say, “Why talk about public company valuations?”

Public companies that are similar to a private company in terms of their industry and operating business (i.e., “comparables”) are relevant to the valuation determination, but not overly so. First, public companies are generally much larger and more valuable on an absolute dollar basis than their private comparables.

Second, they are by definition far more liquid, meaning owners of public companies can buy and sell shares easily in the public markets, versus private companies where the ability of a shareholder to buy and sell shares is quite limited. Greater liquidity of shares generally makes those shares more valuable.

Finally, companies that have gone public have been thoroughly investigated (i.e., “due diligenced”) by investors and public market regulators, ostensibly lowering the risk of investing in that company. All other things being equal, the lower the risk of something, the higher its value.

(As a caveat, there are more and more situations these days where private companies have become so valuable that their valuations exceed the valuations of public company comparables.)

Given our assumption that the valuation of public companies usually exceeds the valuations of private companies, and usually greatly so, how do we use comparable public company valuations? Well, you use them as the high-water mark of your valuation considerations.

In one of our case studies, Patsy’s Paws Pet Place has annual EBITDA of $1MM. She goes to Yahoo Finance or some other online financial information site, performs a search and finds that there are five publicly traded pet services companies. She reads up on each of them and finds that four are much larger than her company but generally offer the same types of services as her company. The business of the fifth is quite different from hers. So, she ignores that one. Then she sees that the four comparables are trading, on average, at a 12X EBITDA multiple. This means that, on average, investors in those companies value the companies at 12 times the EBITDAs generated by those companies. Given her company is private and much smaller than those public companies, her company is almost certainly worth less than $12MM, or 12X EBITDA. So 12X EBITDA is the high-water mark of her valuation consideration.

GROW and SELL Advisors, wholly-owned by Traversi & Co., LLC, is a premier sell-side M&A advisory firm – a boutique investment bank – serving the lower middle market.  Visit us here.

For a short video clip on this topic, click here.