Guideline Public Company Method
In this article, we will tell you all about the market approach, the valuation method and the advantages of the guideline public company method.
Investors in publicly traded companies can see the value of their investment any time they want. All it takes is a couple of clicks on the stock exchange, and they can see their value of their holdings in real time. But out of all the businesses in the US, not even 1% are publicly traded. The majority of them are all privately held businesses, and investors in private companies do not have the luxury of getting a value for their investment at any time.
So how are they valued then? Well, investors use one of the various methods available to value a company. In order to determine a close to an accurate value, they have to choose the right technique. The market approach is a more popular method as it is regularly shown in the news or referred to when talking to investors about valuation. Investors use the guideline public method to value the company because it gives them a close to an accurate market value of the company. This is done by using various companies’ data that is similar to the target company and comparing them to determine a value.
Business Valuation – Market Approach
Business valuation needs to be done the right way for determining the correct value. The market approach is one method that helps you determine a value close to the real value of the company.
Understanding market approach valuation method
The market approach is a technique through which you can estimate the value of a business based on a similar asset’s selling price. This is done by comparing both assets. In this process, data will be derived from various similar private or public companies that are comparable, such as the last transaction, the sale of shares, listed securities, or a market quote. This data will then be used to derive multiples to estimate the value of the target company. This approach is relative as it values the company or the intangible asset relative to actual transactions of other similar assets.
This is done by the use of multiples and by using them as benchmarks. Multiples are tools used for financial measurement to value one metric as a ratio to another, some of them are EV/EBITDA, price to earnings ratio, and the price to book ratio. The use of metrics helps to close the little gap of differences between similar companies and the target company. The financial metric relevant to the company being valued will be multiplied by the price. This gets you to arrive at an estimate.
Two market approaches
Market approach can be further divided into guideline transaction method and guideline public company method.
- Guideline Public Company Method – This method requires you to identify comparable businesses and get the share price for their listed securities. In the majority of cases, the share price that you get from the public market only constitutes a small portion of the stake. This method relies on the availability of recent data. But when determining the value of a small business or a startup, it may not be appropriate. While using the data of the public business to determine the value of a private business, there are adjustments that are required in the benchmarks. The benchmarks that need to be adjusted are the growth potential, business lifecycle, size, capital structure, etc.
- Guideline Transaction Method – The guideline transaction method requires you to find the past transactions such as mergers, acquisitions and divestitures of similar comparable companies. Transactions like them can represent a majority or minority stake. The data of prior transactions can be derived after finding the business industry the company uses. With that information, you can use industry classification methods like NAICS and SIC and get their past transaction values. To get an ideal guideline transaction, the company you choose should be in the same industry and have similar business operations. If there is no direct comparison available for the companies, you can use other relevant information after some considerations about the product and market. Adjustments are required in the transaction information for some specific factors like employment contracts, non-compete agreements, etc.
|Market Approach: Three Methods|
|Guideline Public Company||Guideline Transactions||Prior Transaction Method|
|Based on the observed multiples of comparable companies.||Based on pricing multiples from the sale of entire companies.||Based on actual transactions in the stock of the private company.|
Guideline Public Company Method (GPCM)
What is the guideline public company method?
The guideline public company method is a popular valuation method because most people hear about it in presentations or on the news. This method helps you identify the price of an individual share in a company in the public market in order to derive the value of the share of your target company. The companies that you choose to compare are subject to the same dynamics of the industry.
The valuation multiples that we calculate from these businesses will give us an indication on the value an investor in the market will be ready to pay for a similar business, i.e. the target company. In order to make the comparison more realistic and close, we will look at factors like business size, operating characteristics, and geographical regions.
What is a valuation multiple?
The tool used to do comparisons is called valuation multiples. The multiples are the ratios that help relate company value to a measure of the business performance financially. The valuation multiples that are commonly used in valuations are:
- EV to equity
- EV to Assets
- EV to EBIT
- EV to EBITDA
- EV to Net Income
- EV to Gross Profit
The Principles behind the multiple
The principle behind the multiple is that each individual multiple is reflective and contributes to the value of the entire business. This method relies on an assumption that the list of selected public companies should be similar as they produce the equity multiples that will help determine the value.
The multiples that are produced through the process reflect the perceived fair value and the risks associated with the shares on that certain date since they are based on the reflection of the market value of the comparable business equity pricing. This will limit adjustment to the multiples based on the regulatory factors, industry news, and economic activities.
Advantage of guideline public company method
The advantage of the guideline public company method is that with the valuation date, the share quotes can be derived. Additionally, you can derive the financial data of the business from the closest quarter from the date of valuation. Since the data is new, the comparable business data is dynamic. The need for market adjustments is low as all the current market forces have already been factored into the price of the share at the valuation date.
This method relies on information and the advantage to this method is that there is a lot of data available for free to anyone. Additionally, the information on privately held companies such as their transactions have to be analyzed and verified. This is done by a qualified third-party independent professional and so the information will not be wrong.
Disadvantages of guideline public company method
The disadvantage of the guideline public company method is that this technique pertains to the size of the business in question. The common issue here is that businesses are more diversified and sometimes this is not reflected. They can have operational diversification and greater revenue with a wide geographical reach. But this is not factored in the multiples while determining the value.
How to Implement Guideline Public Company Method?
In order to implement the guideline public company method you need to follow the steps given below:
1) Find a list of suitable comparable public companies (Search through SEC- EDGAR, Yahoo Finance, Google Finance)
For you to search for companies that are similar to your target business, you will have to search online on trusted and certified websites where the data is available. There are both free and paid ways to identify these guideline companies:
- Google Finance or Yahoo Finance – These are online platforms that will provide you with key information on publicly traded businesses. After you have found a few good businesses for your target, you can look for their competitors on Google or Yahoo finance. This will help you make your list faster.
- SEC – The Securities and Exchange Commission has a tool for searching such data called EDGAR. This tool allows you to search by the code of the industry, providing you with a list of all the public businesses that are in the industry you are looking for. This tool will give you a handful of data, you will then have to narrow it down to ensure that the businesses are similar and comparable.
- Cap IQ – This is a paid platform. This resource is very useful as it provides you with the research and analysis on publicly traded businesses. This tool is handy in identifying businesses that are similar to your target company.
2) What Guideline public company price should be used in calculating multiples
The Guideline company price needs to be of companies that are very similar to your target company. A majority of the multiples needs to be rescaled in order to adjust for the company’s size. The ideal guideline public company price should be of a company that is comparable to yours.
3) Calculate guideline valuation multiples
You will have to calculate the guideline valuation multiples after you decide what financial measures you have to take for the comparison. Some of them will be the business assets, EBITDA, or revenue. This method uses price multiples from the information of similar comparable companies. Data from various comparable companies are derived, then the multiples are adjusted for it to account for the difference between your target company and the comparable company. Since there is no specific formula for this method the most common one used is the ratio of the market capitalization.
4) Adjust valuation multiples for DLOM (Discount for Lack of Marketability)
It is essential that you make the valuation multiples factor in the differences of a public and private company. It needs to be suitable to compare. The common source for DLOM information is pre-IPO prices and restricted shares compared to the sale of a fully marketable share. This should be within the same company.
5) The type of value produced by the Guideline public company Method
One essential part of this method is the value it produces. Sale of individual shares sold in the public market underlie the predicated information. So the value that is determined by this method is a minor marketable value of the equity. In order for you to convert it into a privately held business interest will require a major consideration in the form of marketability discounts and control premiums.
Guideline Public Method Example
Let us consider an example and collect information on companies and compare them to the target company. Zebra Ltd is a private company in the clothing industry. Let us use the comparable companies to derive its value. These are the data that we have derived from the comparable companies.
|Comparable company XYZ||Comparable company ABC||Comparable company Zero||Zebra Ltd|
|Mkt value of equity||$60,000||$128,000||$51,200||-|
|Mkt value of Debt||$40,000||$60,000||$20,000.00||-|
When we look at the prior transaction of the comparable companies, even though the dates of the transactions can be different, we can determine the forecasted value by using the EV/sales ratio. This gives us an average of 1.07, from the values for each Company of XYZ, ABC Zero. This 1.1 is then used times the company’s sales (revenue), ie. 1.07 X $64,000, resulting in $68,610. This is done by assuming that the growth outlook of the companies has not changed between the two different dates of the transactions.
Since the companies are very similar and comparable, there is a low mismatch because of factors like marketability, maturity, and size. However, the slight changes can also be adjusted. Since we have three comparable companies, we use the average of the three ratios. There are two ways that this method can be done, data of similar companies or average/median.
If you use the transactions, you indirectly adjust the valuation to account for the minor differences like control, size, etc. between the three transactions and the target company. If you use the average values, you will have to adjust for the differences. This is done so by deriving the average of the metrics. By doing so here and adding the total of all the metrics we estimate the value of Zebra Ltd to be $69,362. In this way using all the multiples, the subject company value is derived.
Need Expert Assistance in Valuing Your Business?
Valuing your company might seem like an easy task but there are some key things that you might mistakenly miss out on while calculating. Also for any valuation of a private company, ie. 409a valuation, to be audit defensible, it needs to be performed by an independent third party professional. This is why you should involve a professional.
Eqvista is backed by valuation analysts that will help you value your business. Eqvista also provides tools to assist you with cap table management and shareholder management. Get in touch with us today for a professional valuation of your company.