As the title says. Have a request from a family member to value a small services business; one of the company owners is looking to sell a stake. I have solid accounting knowledge and experience with valuing publicly trading companies but no experience with small privately held companies. Prefer help with someone that has experience in this area.
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Triangulate value with different valuation methods. Assuming you dont have access to proprietary transaction data bases, I would rely on public company multiples and DCF.
With respect to public company multiples, all of the valuation metrics are publicly available (Yahoo finance). Go through 10ks to get relevant operating metrics (revenue/EBITDA) of comps. Try to be thorough in estimating the normalized level (exclude items that are clearly one-time in nature).
Apply a control premium to the range of multiples. Public company share prices are on a noncontrolling basis. Typically, though debatable, there is a premium for control. It could be tricky to estimate this premium, but 15% is usually a safe estimate (supported by various studies).
With respect to DCF, you need to estimate a WACC. Rely on modified CAPM. Pull the unlevered betas of the comps (same comps from public company multiples), take the average or median and relever for the target capital structure. To do this, refer to modigliani miller/the Hamda method (google it).
If forecasts are not provided, build your own. Keep it straightforward and high level. Nothing fancy unless clear guidance is provided. Stable revenue growth, normalized EBITDA margin and working capital levels, etc.
Your DCF value should reconcile to your public company multiples valuation. Apply an additional risk premium to the cost of equity to bridge the two indications of value. This additional premium reflects non market risk variables (size, liquidity, etc.).
I'm skipping a few things but this is the process in a nut shell. Remember that its actual capital structure is not what's relevant. Refer to leverage ratios of comps if clear guidance isnt provided.
I would ignore what the others above said about comp to public companies. Completely irrelevant when you're looking at a company doing $3M - $4M a year in top line.
lol @ the monkeyshit, LMK how many companies you've run/bought/sold in this rev range.
I would agree, but the valuation guys insist on using them. It's mind-blowing to think about how starkly different public companies are compared to this little business services company that almost certainly has some concentration risk at the customer, employee or supplier level. Throwing out some multiple range and assigning some arbitrary discount is one of the silliest exercises in finance, and there are plenty of them.
I'm looking at a PE companys quarterly valuation report for its investments. Lo and behold, public market and transaction comp multiples used to support the selected mark of a small business (micro cap).
It's just crazy to me how fundamentally you guys misunderstand the application of market multiples. Different industry's have their own risk/growth profiles. That's what you're trying to capture/understand when you pull market multiples or, similarly, betas. It's the price paid per dollar of revenue, per dollar of EBITDA, etc.
Like I said, it's definitely not perfect given the size, but it's something. It's a supportable starting point for an analysis that will require certain adjustments by the advisor.
It's certainly better than fictitious unlevered LBO models with arbitrary required return hurdles.
So this PE Company that you are look at is what size? Certainly not $3-4mm in Revenue if it's in the portfolio of a legitimate firm.
Secondly, nobody is arguing that a formal valuation uses this and would probably be worthwhile in this situation (minority stake of a micro market company) because it gives an independent valuation that will/can be upheld in the court of law. However, valuation reports are academic-based and not reality-based (e.g. expected value if you were to actually sell the business on the open market). If you say the business is valued at 1x Revenue, it will likely trade higher or lower than that because of X,Y,Z.
My criticism was that, on top of the flaws and assumptions in the DCF and transaction comps, public comps provide an even poorer basis for valuation for a business that small because of a multitude of things, including: overall size, demand for the asset, customer/supplier/employee concentration, customer strength, end market diversification, economies of scale, contracts usage/robustness, supplier power, buyer power, liquidity, cost of capital, accounting, IT systems/security, marketing, etc. Public companies are vastly different than private ones, particularly small businesses (this isn't even a MM PE fund's port co.) So, no matter what arbitrary discount you take, it is never going to be scientific. There are simply too many variables.
Exactly. mbahopeful88 should be ignored completely OP. You'll look really bad trying to pitch anything using his methodology.
its why hes an accountant
So to answer your first question, the portfolio investment is generating about $20M in revenue and the fund has about an 80% equity stake. Its larger than the company here, but still micro cap by any standard.
Next, and this really the crucial part, valuation methodology doesn't simply go out the window because of a lack of comparability in a few dimensions. That's where the expertise of the advisor can add value. Size does not render the excersise useless, just more complicated.
Next, it's super fucking easy to poke holes in an analysis and not provide any solutions. It's better to have some support of a value rather than a completely arbitrary number based on a made up return hurdle.
In other words, the exercise I described tries to remove arbitrariness, although not perfectly, while yours embraces it fully.
Also, with regard to transaction comps, you can find micro cap transactions, so not sure what your point is there.
Just a few notes about some of the shitpost responses from the hardo buyside guys.
The OP is effectively providing advisory valuation services on behalf of a family member. He is not being tasked with selling the business or with buying another business.
He has not been given any guidance on hurdle rates and leverage doesn't appear to be a relevant factor. As such, an LBO analysis is not useful here. It certainly wouldn't take priority over traditional valuation methodology.
The hardos dont seem to understand the concept of market multiples. They reflect the price the market is willing to pay per dollar of operations. This method is applicable to small companies (may sound funny but think of shark tank. Dont the investors think in terms of multiples when evaluating small businesses?). Of course, you should account for differences in size when selecting multiples, but the method is still applicable.
Transaction comps would be best here.
This has been just an awful discussion to read through.
The present value of any investable asset is the risk-adjusted, time-weighted stream of future cash flows. Turn it around and read it again: the present value of ANY investable asset is its future cash flows, weighted by time, and adjusted for risk.
The reason it's easier to value bonds than small private companies isn't because the math is different, it's because it's just easier to determine the variables. Evaluating the future cash flows (and their growth) for a small business is hard and ambiguous. Evaluating the risk associated with those cash flows is hard and ambiguous. Evaluating the macro risk surrounding an industry (or value chain segment of an industry) is hard and ambiguous. As such, most valuation techniques are borne out of some way to try and mitigate that ambiguity. Understanding why those techniques work is the only way to arrive at a useable answer in a case where data are difficult to find and opaque, like for valuing small, privately held businesses.
Comps are useful for generalities, but I've been doing this for longer than most of you have, and I've yet to come across a perfect comp. There are transaction dynamics and growth and risk profiles to businesses that don't translate to some other "asset-light business services company" that happened to sell for 9x EBITDA or whatever two months ago. Also, the "triangulation" method is total bullshit; if you need to find a valuation for a niche like a pharmaceutical marketing company, finding 5 pharma companies and 5 marketing companies and averaging them out gives you roughly a pile of garbage.
Your best bet is as a few commenters above described: you have to have some view on the growth prospects of the company independently. Given that, you can look at how the market has valued companies of similar size and future prospects (they may be from the same industry, they may not). If you have all of that, then you can use some discounting framework to have an approximate view on that company's valuation. If you don't, then it doesn't matter what technique you're using, you're just guessing.
Postscript: the LBO method is a totally dogshit valuation method. It's a back-of-the-envelope way to arrive at a willingness to pay for an asset, and you can assume that if multiple sophisticated parties are competing for an asset, then the price paid for that asset may approach the highest bidder's willingness to pay. It can be a useful data point when trying to figure out the limit of what multiple PE bidders might approach in a process, but only as context. On its own, since it completely relies on a totally arbitrary IRR target and ignores the size, growth, timing, and risk of cash flows that we talked about earlier, it is a completely useless way to value a business.
Yes, I'm aware that plenty of PE firms use this as a valuation method. It's a dumb method.