Finding the Best Value: Comparables Method
“VCs like acquisitions as much as IPOs because the acquiring companies often can rationalize paying large multiples over the current valuation of the startup.” — Steve Blank, Silicon Valley veteran
In the last 20 years Google, a company founded in September 1998, has acquired approximately 243 companies (12 per year) in more than 18 countries in more than 17 different sectors. Among Google’s main acquisitions are YouTube (for USD$1.7bn in October 2006), Fitbit (for USD$2.1bn in January 2021), Waze (for USD$1bn in June 2013), Zagat (for USD$150mm in September 2011) and Motorola (USD$12.5bn in August 2011). The company currently has USD$26.5bn in cash and USD$110bn in financial investments that give it significant power to continue making acquisitions in the following years.
The valuation of these acquired companies is carried out through different methodologies. One of them is the intrinsic value that is calculated through discounted cash flows (DCF). In addition, they use the comparable valuation methodology to determine the value to be paid by a well-established company or by a startup. This valuation by comparables is carried out taking into account public companies and companies acquired by other organizations (M&A).
When valuing companies by market comparables, it is important to have a similar comparison looking for the implicit value of the listed company or a division and reflect a control or synergy premium.
The process to carry out this analysis is as follows:
- Determine the group of comparables
a) By operations: It has similar operations; products or services, distribution, cost structure, geography, clients, among others.
b) By financial aspect: Sales size or market capitalization , capital structure, margins and profitability, management experience, among others.
Sometimes it is difficult to find a perfect comparable, so you will have to use your judgment when carrying out this process. Sometimes the comparable may be a private company or a division within a large organization, they may be unique companies in their line of business, for this it takes estimates and creativity. You could also use other more suitable valuation methods.
2. Gather the right financial information
Information on public comparables is relatively easy to access, mainly in developed markets. Perhaps, derived from the nature of your business, you have confidential information from other companies that you could use to develop your analysis while preserving the confidentiality of the sources.
3. Enter the financial information in your valuation model and normalize for non-recurring events
Selected comparables may have financial elements that are not part of the normal course of business and will need to be adjusted, for example, restructuring charges, gains or losses from asset sales, legal liquidations and asset impairment. This can be found in the different lines of the income statement, in the cash flow or in the discussion and analysis sections of the management reports (MD&A). Your objective is to evaluate a going concern with its profits and cash flows.
4. Calculate the relevant historical or future multiples
The main multiples are:
- EV / EBITDA: Derives the value of the entire organization, including debt and equity.
- P / E: Provides the value of the equity portion of a company.
Other relevant multiples in the startup world are:
- GMV, GTV, Sales, # of users, # of transactions, among others.
- Another multiple is capital efficiency, which is measured as: Investment amount in the past round / (current round pre-money valuation — previous round pre-money valuation). It measures the effectiveness of the use of the resources raised in a startup capitalization round according to the valuation increase with respect to the subsequent round.
5. Forecast the future financial performance of the company you are evaluating.
It is important to calculate the EBITDA, EPS, and cash flow to derive the valuation.
6. Apply the appropriate multiples of the comparables used to the finances of the evaluated company to derive the implicit valuation range.
Another methodology of comparables is to consider the valuation with acquisition comparables. This reflects the value of similar transactions adjusted for the control and synergy premium. It is important to consider time and industry trends, the nature of M&A (friendly vs. hostile), and consideration of payment (cash, stocks, or a combination of both).
The process of this analysis is very similar to that of market comparables and is summarized in the following steps:
- Determine the list of appropriate transactions.
- Gather the right financial information.
- Enter the financial information in the valuation model, calculating the value of the transaction, the value of the offer, and normalizing non-recurring events.
- Calculate the relevant multiples: Value of the transaction between sales or EBITDA, offer price per share / earnings per share.
- Analyze the results.
- Derive the implied valuation range.
The acquisition of startups backed by Venture Capital funds has grown rapidly in recent years. This growth has occurred since there is cheaper capital in the market, there is great dynamism in the creation of Special Purpose Acquisition Companies (SPAC) and there are startups that have shown their value and resilience to the recent pandemic. Digital transformation has accelerated and a corporate innovation channel growing in use by large corporations is M&A.
“ The key to making acquisitions is being ready because you really never know when the right big one is going to come along. ”- Jamex McNerney, Served as President and CEO of The Boing Co.
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Gonzalo Soriano. VC Investor at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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