Valuation Methods Most Suitable for Companies in Highly Competitive Markets
Did you know that in the first seven months of 2024, more than 19,000 mergers and acquisitions (M&A) have happened? The highly-competitive consumer products and services industry accounted for almost 6,000 of these deals.
The high volume of deals in competitive industries makes business valuations very easy. After all, the main issue with private equity business valuations is the lack of comparable data.
So, in 2024, a consumer product or service company would find it much easier to calculate its valuation than other companies.
In this article, we will discuss how companies in competitive industries can leverage this abundance of data in business valuations. We will also go over the appropriate business methods through some examples.
Importance of proper valuation methods in competitive markets
Before we speak about the correct methods let us first talk about the importance of accurate valuations in competitive markets.
This is vital for the following purposes:
Strategic planning and decision-making
A business valuation can help you understand your market position and financial health. These insights will help you develop long-term growth strategies. This is particularly important in competitive markets where strategic missteps can lead to significant losses and missed opportunities.
For instance, Skype used to dominate the video calling space, however, they made the strategic misstep of focusing on unnecessary features like emojis rather than maintaining the video call quality. As a result, when remote work caught on, Skype lost its market share to Zoom.
Fundraising
When you approach investors for funds, you will typically have a valuation in mind. This must accurately reflect your company’s current position and potential. You must back this figure with a sound report. Otherwise, investors would doubt your company’s value or you may lose your footing in negotiations.
In 2019, WeWork, a real estate company, was valued at $47 billion. However, in just two years when it went public, it was at a valuation of $9 billion and two years after going public, the company filed for bankruptcy.
We can safely say that WeWork received an inaccurate and unnaturally high valuation because of market hype and trends prevalent at the time. Eventually, when the issues in governance and lack of profitability came to light, the company suffered significant drops .
In the case of WeWork, the overvaluation not only affected the company’s ability to raise funds but it also made it extremely difficult to make any sort of exit.
Tax compliance
When you issue stock-based compensation to your employees, in the US, you must get a 409A, and in the UK, you need to get an HMRC valuation. Otherwise, the compensation you issued may not be considered tax-compliant. This can result in hefty fines and penalties. Such instances can also make it difficult to attract and retain employees. In a highly competitive market, this can prove fatal.
So, you must make a note of all regulations that apply in your jurisdiction and get an accurate one.
To summarize, accurate business valuations are indispensable for building growth strategies, securing financing, and tax compliance.
How to value companies in highly competitive markets?
In highly competitive markets, it is easier to value companies using methods that come under the market approach. The main methods under this approach are as follows:
Comparable company analysis (CCA)
The CCA method involves comparing the performance of your company with a similar publicly traded company. If you operate in a highly competitive market, finding such a company should come easy.
You must ensure a match as close as possible based on size, product portfolio, and geographical segments. Then, you must note any differences between your company and the company you chose. Then, you just need to discount or apply premiums for any key differences.
To start with, you will need to apply a discount to your company’s valuation since its shares will be less liquid than a publicly traded company. Similarly, you will need to make adjustments for differences in profit margins and revenue margins.
Example for Comparable company analysis:
If you took the example of a publicly traded company operating in a different region, you will need to account for the difference in market opportunities in the two regions.
To understand how this method works, we will take an example where the public company has a bigger size, operates in more geographical regions and also has a more mature product portfolio.
*Please note that this is only for illustration and in a competitive market, you should find a closer match easily.
In this example, we will try to find the valuation of TechStar based on what we know about SANA Corp. Let us take a look at the financial information for these companies.
Particulars | TechStar | SANA Corp |
---|---|---|
Revenue | $50,000,000 | $5,000,000,000 |
EBITDA | $10,000,000 | $1,000,000,000 |
Net income | $5,000,000 | $600,000,000 |
Market capitalization | N.A. | $15,000,000,000 |
SANA Corp operates in North as well as South America, while TechStar can only operate in North America. The difference in size is evident from the financial figures. Also, SANA’s products are well-rounded when compared to TechStar’s prototypes.
Now, let us calculate the multiples for SANA Corp.
Name of multiples | Formula | Calculation | Valuation multiple |
---|---|---|---|
Revenue multiple | Revenue / Market capitalization | $15 billion / $5 billion | 3 |
EBITDA multiple | EBITDA / Market capitalization | $15 billion / $1 billion | 15 |
Net income multiple | Net income / Market capitalization | $15 billion / $600 million | 25 |
Now, let us apply these multiples to the financials of TechStar.
Valuation as per | Calculation | Valuation |
---|---|---|
Revenue multiple | $50 million X 3 | $150,000,000 |
EBITDA multiple | $10 million X 15 | $150,000,000 |
Net income multiple | $5 million X 25 | $125,000,000 |
Since there are considerable differences between the two companies, we will apply a discounting factor of 25%.
Valuation as per | Valuation | Discounted valuation |
---|---|---|
Revenue multiple | $150,000,000 | $112,500,000 |
EBITDA multiple | $150,000,000 | $112,500,000 |
Net income multiple | $125,000,000 | $93,750,000 |
So, TechStar valuation = $112.5 million+$112.5 million $93.75 million/3
= $106.25 million
Precedent transactions analysis (PTA)
If you cannot find a comparable publicly traded company, you can use the PTA method. Here, you need to find multiples based on valuation and revenue data. Such data is typically easier to find than entire financial data when it comes to private companies.
Here too, you need to find the closest match based on factors like size, product portfolio, and geographical segments. If you cannot find a close enough match, you will need to make the appropriate adjustments.
One of the accepted methods is PTA. So, we will explore this method through an example in the following section.
After looking at the examples of both, you will realize the following:
Methods | Required data |
---|---|
Comparable company analysis | Company-specific and detailed data |
Precedent transactions analysis | General data for a large group of similar companies |
409A valuations in highly competitive markets
One of the accepted methods is the illiquid startup approach, that can help you attain a safe harbor status which goes a long way in tax compliance.
Let us see how to conduct a 409A valuation for a company in a highly competitive market.
We already know that the consumer product and services industry is highly competitive.
So, let us look at an example involving one such company- Fressence, an organic personal care company.
We will assume that this is an early-stage startup and its annual revenue is $500,000. From recent equity transaction data, we know the following details about similar companies:
Name | Annual Revenue | Valuation | Valuation Multiple |
---|---|---|---|
PureSkin Essentials | $800,000 | $2,000,000 | 2.5 |
OrganicRadiance Co. | $700,000 | $1,925,000 | 2.75 |
GreenLeaf Naturals | $600,000 | $1,800,000 | 3 |
FreshBloom Organics | $1,000,000 | $2,625,000 | 2.625 |
ZenBeauty Naturals | $1,500,000 | $3,750,000 | 2.5 |
EcoGlow Products | $750,000 | $2,000,000 | 2.666667 |
EarthPure Essentials | $1,100,000 | $3,100,000 | 2.818182 |
HerbalGlow Solutions | $900,000 | $2,475,000 | 2.75 |
GreenEssence Products | $850,000 | $2,500,000 | 2.941176 |
NaturalAura Brands | $1,200,000 | $3,000,000 | 2.5 |
It is common practice to multiply a company’s revenue with the market multiple to arrive at the result . First, we need to find the multiple through the following formula:
Market valuation multiple = Market valuation/Market revenue
So, the market multiple will be:
Market revenue | Market valuation | Market valuation multiple |
---|---|---|
$9,400,000 | $25,175,000 | 2.68 |
So, Fressence’s enterprise value should be = Market valuation multiple × Fressence’s revenue
= 2.68 × $500,000
= $1,340,000
Since we are assuming that Fressence is illiquid compared to the abovementioned startups, we must discount the enterprise value to get the right result.
Fressence’s enterprise value | Illiquidity discount | Fressence’s valuation |
---|---|---|
$1,340,000 | 20% | $1,072,000 |
So, we can conclude that Fressence’s 409A valuation is about $1 million.
Eqvista- Precise Valuations for Scaling Cut-throat Markets!
In highly competitive markets like consumer products and services, conducting accurate business valuations is both crucial and relatively straightforward. Since there is abundant comparable data from numerous M&A deals and fundings, precise valuations are possible.
Methods like comparable company analysis and precedent transactions analysis provide reliable frameworks for determining a company’s worth in these dynamic sectors.
Given the importance of accurate valuations for strategic planning, fundraising, and tax compliance, it is essential to partner with experienced professionals who can leverage market data effectively.
This is where Eqvista’s business valuation services can make a significant difference. Our team of expert analysts combines in-depth industry knowledge with cutting-edge techniques to provide you with precise, defensible valuations tailored to your company’s unique position in competitive markets.
Get in touch with our team to learn more!