The Art of the Multiple
Grata's Nevin Raj explores how to add color to private company valuations
The go-to techniques for company valuations are public company multiples and precedent transactions. I think of these as primary colors. They are a foundation, a place to start. But you run into issues when these are the only data points being used, because there are so many shades of gray.
There are several instances where industry multiples hide or distort the full picture of what’s going on in a particular company. Maybe a company has a cyclical business model that the multiple can’t capture, or perhaps macroeconomic trends are in play, or there’s a shift in a company’s strategy.
Businesses have a tendency to shift strategies, add products or even change the industry they operate in. One example from McKinsey and Company’s article, “The times for multiples: Five situations when multiples need more than a second look,” found that from 2003 to 2005, one company traded at an EV multiple of 10-12x two-year forward EBITDA. Things changed in 2006 when the company expanded to medtech and life sciences.
It took 10 years for the company to fully transition, and for the underlying multiples to reflect the profitability of its new business model.
It wasn’t until 2017, 11 years after the transition began, that the company’s multiple began reflecting the new industry with EBITDA multiples of 15-17x instead of 10-11x.
The market missed this change. Any peer comparison relying on the 2006 industry multiples would (and did) produce incorrect projections.
One lesson here is that industry multiples need to be adjusted to include all industries a company is operating in. But how can investors go one step further to safeguard their M&A activities against such drastic miscalculations?
The answer is to go another level deeper in your data. There’s more publicly available data out there that can factor into your valuations.
Private Company Data
It takes a lot of data to understand a company’s financials and strategy. Often times you don’t have this data until you’re weeks into a diligence process and deep in a data room. But what if there was a way to add more color, more accuracy to your valuations, before you open the books?
There are two widely accepted data points that have the highest impact on multiples:
- Size/Scale: How big is a company? How profitable?
- Growth: How fast is a company growing or shrinking?
Revenue and EBITDA are often challenging to obtain for private companies, so your best bet is to find an industry proxy. For technology and services businesses, that proxy is most likely employees. For healthcare and consumer services businesses, that could be locations or number of reviews. For e-commerce, it could be web traffic. The key to accurately estimating these three factors is consistent, not necessarily perfect, data. At scale. Because multiples are all about relative value.
One of the most important “x-factors” of valuations is what I call “remarkability.” Is there something that makes this company special? A differentiated technology, natural moat, better brand, better pricing or scalable distribution partnership? While hard to capture in the data, this can often be gleaned by reading through company websites or, at scale, using a B2B search platform like Grata to cut through the noise and spot targeted characteristics.
In most cases, however, a company’s own data isn’t enough. Market and competitive dynamics also play into a company’s valuation. These are especially important when your industry valuation benchmarks are not representative of the niche your target plays in.
Here are some key elements of assessing a company’s market position:
- Market Leadership: who has the highest market share? How hard will it be to take share?
- Competitive Landscape: How crowded is the space? Investment Saturation: how much “smart” (i.e., investor) money is in the space?
- Fragmentation: How much opportunity is there for M&A? How many actionable targets exist?
Start your Next Valuation Masterpiece with Grata
It’s time to rethink how multiples are calculated. It’s now possible to build a deeper perspective of a company’s valuation before you even have a conversation with a CEO.
This information lives in different places. To do this level of research at scale, you need to lean on the right technology. That’s where Grata comes in.
Grata is the leading business development and research platform for private markets. With Grata, innovative dealmakers are assessing company valuations in-depth and at scale, analyzing company profiles that show private company revenue estimates, executive contact information, growth estimates, ownership details and, of course, remarkability.
It’s time to dig deeper. Add color to your multiples. And find the best targets for your firm.
Nevin Raj is the chief operating officer and co-founder of Grata, a private company intelligence engine for middle-market dealmakers.
Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.