The 3 Step Approach to Comparables Valuation for Business Valuations

Small business valuations

Around 543,000 new businesses are started each month – – that’s over 6.5 million startups attempted every year – – but even more businesses are shut down. About 30% of those businesses fail within the first two years. Half will survive for at least five years, whereas only a third make it to the 10 year mark. If your company is still around 15 years after its creation, you can congratulate yourself as being in the top 25% of new employer businesses in terms of longevity.

At some point during the life of your business, you’ll likely want a business valuation. Whether you need a business valuation report for financial or tax reporting, or are seeking a business appraisal valuation in anticipation of a sale or acquisition, there are three main methods you can use to determine your business’s fair market value: based on your company’s assets, based on its earnings power and risk assessment, or by compare it to similar companies. In this article we’ll discuss the comparables valuation method.

You may be familiar with comparables valuation from stock analyses. Just as you would in investing, the comps valuation approach to business valuation analysis uses key ratios to compare your company to its competitors. The idea is that your company’s value should be comparable to the value of similar firms. As such, the first step with a comparables valuation is to determine the companies similar to yours.

  • Step One: Determining the Comparable Companies

    The group of similar companies you’ll use is known as the “peer group.” Ideally, you want to find publicly-listed companies similar to yours in size and region. If you’re U.S.-based look within the United States. There are 26.5 million companies in the United States. Of those, 5.4 million have employees, while 21.1 million have no employees. Start with the basic company facts to help you narrow down your peer group.

    You can also look for firms who face similar external influences. Think of stocks which may not be in the same business industry but track each other in price regardless. Perhaps you have a house-painting company; try looking at local real estate companies for a comparison. A realtor would have similar clients to you and be affected by similar market forces.
  • Step Two: Gather the Financial Data

    For a comparables valuation analysis, you’ll need data on the same measures and forecasts for each of the companies in your peer group. Some of the most popular measures are a company’s enterprise value divided by its earnings before interest, tax, depreciation, and amortization, or EV/EBITDA; and its enterprise value divided by sales, or EV/Sales. EV/EBITDA and EV/Sales are typically more valid than comparing the price to earnings ratio as you may in a comparables valuation of a stock.

    You can use databases such as Bloomberg or Reuters to gather the necessary financial information. Or, if you don’t access to those databases, you can search through the various companies’ financial reports for the values you need.
  • Step Three: Create your Benchmarks

    Once you have the values you wish to compare for each of your peer group companies, use them to create a benchmark for your company. By calculating the low, high, median, and mean across your peer group, you can compare each company to the group statistics.

    It’s important at this point to make sure you understand why the values for your peer group companies may differ. For instance, one company may have a significantly lower EV/EBITDA due to slower projected growth. Projected growth isn’t an explicit factor in EBITDA, but it does factor into EV by being implicit in equity value. If you hope to have an effective result from your comparables valuation, you should understand the reasoning behind the values you’re comparing.
  • This three step process gives you an overview of what goes into a comparable companies business valuation. It can be a time-consuming process and feel complex, which is why some business owners turn to business appraisal services. With a business valuation firm, analysts will compile the necessary statistics and create a benchmark report for you. If you have questions regarding the outputs, there’s always someone available to answer them.

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