Multiples is a term widely used in lots of valuation theories. But why do we use valuation…
Comparables: How To Use Them To Defend Your Valuation [Video]
Do you prefer podcasts? Listen to the audio here.
In valuation theory, comparables are referred to as those companies or deals that are similar in size, type of company and industry.
Comparables can be very useful for setting your own milestones and projections.
Making any type of financial or business planning is simply making an educated guess about the future. “Educated” here means that you decide on a set of assumptions, that is the most reasonable based on the information you have today. Comparables is just one part of the process of gathering that kind of information.
This is particularly important to startup companies, because they have little-to-no history and the history cannot be used as a source of information.
Researching comparable firms is one of the ways to compensate for the lack of financial track record.
Before identifying comparable companies, you need to identify the features to focus on for your own company.
5 elements to focus on
1| Geography – the country, the market conditions in which you play.
This really depends on the type of business. If, for instance, you are based in the Netherlands, but your business is focused on Eastern Europe, try to focus on that market in your search for comparable businesses.
If you have a new type of business, something that is not even recognised as a sector yet, try to think about companies that are introducing the same type of innovation. You should use your own judgment and you do not necessarily have to stick to the label of the industry.
3| Stage of development
It is recommended to define the stage of development based on the type of funding – pre-seed, seed capital, angel rounds, etc. Be honest to yourself about the stage of development – that is the only way you can find companies that are similar to yours.
4| Business Model
You need to figure out if you are, for example, a SaaS company or a corporate sales company with B2B large deals, an SMEs oriented company with annual licences or a marketplace.
This distinction is based on your pricing structure, as well as the type of product that you are offering.
5| Target audience
If we take Equidam, for instance, we are introducing innovation in valuation. However, there could be companies introducing innovation in deal management or in the legal aspect of valuation. We would be all serving the same type of demand, which also has the same type of dynamics and occurrences.
Fine-tune the list
Once all these elements are taken into account and a list of comparable companies is drawn, you should identify few companies that are most important to leverage on when making your financial projections. There are three tiers of companies to focus on.
1| Direct competition
Stage of development should not be taken into consideration when comparables are direct competitors, because a direct competitor that is at a later stage has much more track record. You can use their track record to learn and to know what the best possible scenario is. In this way, you have benchmarks and limits to guide you when making projections.
You can look for direct competitors in companies that are doing something very similar to what you are doing and are operating in geographies that are similar to yours. If you are developing a new type of mobile phone provider in a developing country where you are a first-mover, you can use a similar business that introduced an innovation in similar economic conditions.
2| Public companies
It is very important that you select companies that are public – listed on the stock market, specially when setting financial ratios. Public companies are required to disclose financials at least on an annual basis. You can use this information to see the average performance your business will revert to when it reaches maturity.
A SaaS business that is serving SMEs, for instance, can use HubSpot. They are purely a SaaS company with recurring revenues and they have been public since 2012. You can use their disclosed financial information to see what the ratios are in terms of revenue growth, recurring versus non-recurring revenues, extra costs, costs for acquisition or retention, etc.
3| Recent funding rounds
You can use this type of comparison for the funding size. It is important to take companies that are in the same geography or in the geography of your potential investors.
If you are seed stage, and there are other companies who have received seed funding, it could be a good way to convince investors that they are not out of the market conditions by investing in early-stage company. This is mainly used to show investors what is reasonable for the stage of development that you are at.
Information to look for
Look for data, numbers. Example of the data you should look for are:
- Recurring vs non-recurring revenues
- Costs – for acquisition, retention
- Financial ratios
In conclusion, you should look for the numbers that can help you come up with your own targets. Keep in mind that some public values can be a little overstated by companies for marketing purposes.
You do not need to buy subscriptions to data providers. You can do the research yourself. You can look up tons of connected articles on Google News, you can look for company PR. Crunchbase or Angel list are helpful when looking up funding information. For companies that are based in the US, you can even look up SEC filings.
Equidam relies on a database of 10M data points on market transaction to find comparables and provide accurate financial parameters and valuation!
Bottom line: not only comparables are useful in shaping your financial projections, but also you will be able to defend your assumptions when talking to investors and set your own benchmarks.
What is your experience with identifying comparables for financial projections? Did you have any difficulties or, on the contrary, managed to find useful information you could leverage when negotiation with investors? Share it in the comments!