How do you use relative valuation for mergers and acquisitions?

Relative valuations are the most difficult valuation matrix for an entrepreneur to grasp when pricing his or her company and going to market. This is the reason that an experienced consulting firm must be engaged. Ultimately the client company gets what they pay for. If you are obsequious with a client in this situation you will lose twice. You will be unsuccessful raising any capital for the client company and the existing shareholders will be put at unnecessary risk. As most companies need inorganic growth through mergers and acquisitions to achieve their goals if you miscalculate the initial valuation you will not be successful with accretive acquisition which cost the company higher long term valuations. Get it right the first time!

Relative valuation is a way to determine a company's value by comparing it to similar companies in the same industry. While conducting relative valuation, you may look at things like size, growth, risk, and profitability. For example - To value a Mumbai-based online retail startup, you'd find similar e-commerce companies, check their market prices and financial data, and calculate their valuation multiples. Then, you apply these multiples to your startup to estimate its value. This method gives you an idea of your startup’s worth based on what similar companies are valued at.

Relative valuations or comparables are an effective cursory starting point. Clearly there are many variables that can be dramatically different from one company to another even if in same industry. Consider location, distribution, product shelf, brand, client list, specializations, etc. Many buyers over pay based on the relative multiples used and the rumours of the going rates.

In the realm of mergers and acquisitions, leveraging relative valuation is paramount in gaining insightful perspectives on potential deals. By comparing the metrics and performance of similar companies within the industry, we can gauge the relative worth of the target company. This approach allows us to assess factors like market position, growth potential, and financial health, which are instrumental in making informed decisions regarding acquisitions. Through thorough analysis and strategic application of relative valuation techniques, we can uncover opportunities and mitigate risks, ultimately driving successful outcomes in M&A endeavors.

The relative valuation method compares a company's value to the transactional or market values of similar companies in the same or similar industry. We use it in my valuation group, as it is relatively quick and provides a valuable snapshot of a calculated value based on market-generated multiples.

Relative valuation is popular for mergers and acquisitions because it's simple and relies on real market prices, data and not subjective guess. The method is consistent using the same metrics for both the target and the acquirer, reflecting current market conditions. Additionally, the method is flexible allowing for different valuation multiples and adjustments in various scenarios. For example - If a large Indian IT firm wants to acquire a smaller tech startup, it can use relative valuation to compare market prices and financial data, ensuring a fair price while considering potential synergies and post-deal benefits.

Since valuations seek to estimate the present value of a business over it’s lifetime, a point in time multiple reflecting only current market conditions may be farther from reality. An average or median of the multiples in the recent preceding years up to the current timeframe can be considered for determining a relative valuation

Relative valuation in the m&a setting only works for comparables that are similar to the actual transactions. You should only be using transaction multiples in your analysis as they are the only ones that provide evidence relating to a specific m&a transaction. If you use any other type of multiple in your evaluation analysis and you will be missing items that are unique to m&a transactions like control premiums and competitive bidding.

Based on my experience, I see advantages of Relative Valuation as follows: * Relative valuation estimates a market value by comparing the subject to similar companies that are publicly traded or have been acquired. * Relative valuation is generally quicker to perform when compared to other valuation methods. * Relative valuation relies primarily on objective market data and financial ratios.

It pays to get to grips with realistic valuations early in the process. We’ve all punched ‘business valuation’ into Google. The common formula is 5 to 8 times EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation - different to net profit and in reality a more reliable indicator of the true performance of the business). But consult different outlets so you can develop a ‘range’ or ‘aggregate’ value and understand what ballpark you belong in. Get sums done by accountants, business brokers or by using an online valuation tool. The more you do it, the clearer the picture becomes. You’ll spot themes and repeated concepts that will give you confidence when it actually comes to preparing your business for sale.

Anyone selling anything is prone to overestimating the value. We have a tendency to focus on the work we’ve put in over the years - the missed weddings and birthdays. The anti-social hours. But the harsh reality is any serious buyer may be sympathetic - but it won’t factor into their valuation. To them this is simply the price of being an entrepreneur. What matters to buyers are the clients, the team, IP and the reputation - the building blocks they can use to generate profits in the future. At the lower end of the M&A market, however, businesses are simply worth what someone is willing to pay for them. For owner managed, service based businesses with revenues of $1-$2 million, I would say a valuation of 2 - 4X EBITDA can be expected.

The multiplayer varies in different industries and it increases with the value of the EBITDA. A very rough idea could be: - For businesses making under ￡2 million EBITDA, the multiplier is typically between 1.5-3x the EBITDA amount. - Between ￡2-7 million EBITDA, the multiplier increases to between 3-5x EBITDA. - From ￡7-10 million EBITDA, the multiplier is around 5-6x EBITDA. - Once EBITDA exceeds ￡10 million, buyers will often pay around 10x EBITDA or more.

Different industries have different norms for these multiples. For example, the rental car industry, where I worked, used a multiple of the Average Daily Rate per car to value a rental car business. In the SaaS area, multiples of ARR (annual recurring revenue) and MRR (monthly recurring revenue) are common.

The choice of valuation multiples mainly depends on the industry and stage of the business cycle. An asset-intensive company, may look at the book multiples rather than income/cash flows multiples. On the other hand, a startup with low profit may use revenue as a benchmark.

To adjust valuation multiples in M&A, factor in deal-specific considerations. Recognize and account for synergies, integration risks, and changes in capital structure. Adjusting multiples for these nuances provides a more accurate reflection of the target company's true value within the context of the acquisition, going beyond a simple comparison of financial metrics and aligning with the unique dynamics of the deal.

In relative valuation for M&A, the nuances of comparability are critical. Beyond the typical adjustments for size and profitability, it is essential to consider the evolving market dynamics, such as technological advancements and regulatory changes, which can significantly impact valuation multiples. The growing emphasis on ESG (Environmental, Social, and Governance) criteria could lead to the emergence of new valuation frameworks, necessitating a more holistic approach to assessing value in M&A transactions.

If the company gives access to a particular market niche, that may increase the multiplayer. If the business is due diligence ready with its business canvas and business, marketing and sales playbooks ready, then this will make the business more attractive and easy to scale and it will increase the multiplayer. If the company has more than 20% of its revenue from one client, this is risky and may reduce the multiplayer. If the company has high debt/profit ratio or unpaid taxes, apart from being a red flag, it may lead to reducing the multiplayer.

Use relative valuation in conjunction with other methods like a DCF or LBO analysis - and triangulate the value using these methods. Its not always easy to find the right comparables, and sometimes I've seen comparables being used without an understanding of the transaction or a high level understanding of the comparable's business - so make sure you're clear on why the specific comparable was picked and what adjustments may be necessary to tweak the comparable's multiple.

During pre-deal analysis, we're sizing the target against its peers to gauge its market standing and value. It's about answering critical questions: Is the target priced like a diamond or a dime? Are we looking at a steal or an overpriced offer? During post-deal analysis, relative valuation helps assess the synergy's performance. It assesses the realisation of synergies—cost savings, revenue enhancements, and other strategic benefits anticipated from the merger.

In SaaS M&A relative valuation, beyond financial metrics, consider strategic fit, industry verticals, and market expansion potential. Deals like ClearPathGPS by GPS Insight and Soluno by Actionstep showcase valuing synergy potential. Ideagen's acquisition of Tritan and Activated Insights' merger with Home Care Pulse highlight the importance of new market access in valuation. The Atonix Digital and Prometheus Group deal underscores vertical integration's value. In pre-deal analysis, besides traditional val. metrics, potential for digital transformation and market resilience should be key considerations. Post-deal, the focus shifts to measuring the actual integration success and innovation impact, rather than just financial performance.

There’s a lot of talk in the M&A industry about the magic ‘ ￡1 million threshold’. So let’s focus on it briefly here. It is true, many acquirers become interested from ￡1 million EBITDA. But even hitting that threshold is not enough to guarantee a sale. Many of the larger buyers out there have significantly higher requirements to justify the time and cost of undertaking M&A. Equally, it doesn’t mean you can’t sell if your EBITDA is below ￡1 million - but you may find that you require a strong niche or desirable IP, or both. Depending on your position, you may have to accept the pool of buyers will be more limited. It brings us back to knowing your buyer - or would-be buyers - early in the process.

When using relative valuation in M&A, don't limit comparable companies to direct industry peers. Consider strategic alignment and future synergies, selecting targets with similar growth prospects, customer bases, or technological synergies. This approach adds a qualitative dimension to the analysis, ensuring the valuation reflects not just current metrics but also the strategic value and potential for enhanced performance post-acquisition.

Cross-border M&A can introduce additional layers of complexity in relative valuation, including currency risk, differences in regulatory regimes, and economic conditions. Adjusting for these factors can be crucial in global M&A deals to accurately capture the value of a target company in a different country.

In mergers and acquisitions, relative valuation remains a critical tool, particularly in volatile markets where traditional metrics may raise questions. The importance of context in choosing comparable companies cannot be overstated; factors such as market position, growth potential, and geographic presence can significantly impact valuation multiples. Additionally, emerging trends like ESG (Environmental, Social, and Governance) considerations are increasingly influencing investor sentiment and, consequently, valuation metrics. Integrating these qualitative factors into relative valuation will be essential for achieving a more accurate and holistic assessment of a target company's worth.