Comparing the Value of Your Company to a Similar Publicly Listed Company
Many business owners are aware of the simple (but rudimentary) business valuation method of “PROFIT x MULTIPLE = VALUE”. Clearly, inherent in this formula is the requirement for an appropriate multiple to be selected. Too often we are approached by clients who, after looking at information relating to companies on the public stock exchange (E.G. the ASX) assume that the Price/Earnings (PE) multiples of publicly traded companies can be applied when valuing private companies. However in our experience, doing so almost always leads to erroneous outcomes. This article explains why.
Regulation
Company’s listed on public markets such as the ASX and Dow Jones must meet a number of strict guidelines to be listed and to also maintain their position on the public markets. Their records are constantly audited and also readily available for ongoing analysis by the public. This high level of scrutiny creates a safe guard for investors, lowering the risk of publicly traded companies (in comparison to their private counterparts) which in turn increases the value of public companies.
Size
Larger listed companies are generally valued at a higher multiple. There is a basic principle that the larger a company is the higher its valuation multiple, however there are a couple of specific factors that make this the case, including:
Dependence on a few key staff members: Larger companies have a significant number of staff members that are capable of running the company. Alternatively private companies often rely on a few key founders to run the business which results in a high dependence on them, and generates an increased level of risk for the company.
Brand name: Publicly listed companies through either their rapid growth, or longevity generally have highly valuable brand names. A strong brand name can foster expansion opportunities, customer loyalty, negotiating power, increased margins and numerous other benefits which bode well for future growth, and stability, and are key to a high valuation.
Illiquidity Discount
Assets that are difficult to sell are referred to as being illiquid. Private companies are generally quite illiquid in comparison to their public counterparts. As a general rule of thumb, private companies are often discounted by 20% to 30% due to their illiquidity.
The specific issues arising from illiquidity are outlined below:
Higher trading costs: In order to have an accurate valuation and find a purchaser it can be a relatively expensive process, compared to trading shares on a listed exchange.
Opportunity cost: With liquid assets it is easy to sell your shares after unexpected good results or at a time when the market is viewing the industry favorably. This is not the case with private companies as it can take over 12 months to prepare for and execute a sale.
Uncertain exit and costly exit: Ownership of a private company results in a relatively uncertain and expensive exit. If the company grows, an IPO may be possible, but this can be an expensive process that takes over 12 months to prepare for. Similar a trade sale results in a significant amount of analysis from both the buy and sell-side to ensure a successful and fair transaction takes place.
Information Asymmetry
Publicly listed firms have a great deal of information available to any member of the public regarding their operations and financial performance. They have annual reports, quarterly updates, announce anything that can impact share value, and are consistently subject to independent audits.
This high level of compliance is not applicable to private companies and creates an information asymmetry problem, as owners know a significant more about their company than potential investors which generally means potential investors need to incur greater costs to complete their investment and are assuming a higher level of risk should they proceed with an acquisition.
Find Out More
Quinn M&A’s expert team of business transaction advisors can assist you to with all of your business exit planning, divestment, acquisition and valuation requirements. Contact Quinn M&A today on +612 9223 9166 or submit an Express Enquiry to arrange a confidential no cost consultation with one of our Senior Advisors.
