Market-Based Approaches to Private Company Valuation

How should you adjust in a valuation when using P/EBITDA multiples rather than P/E?

What characteristic would you look for first in your initial search for guideline public companies?

Not quite. Ultimately you do need to adjust the valuation for nonoperating assets, but not because you're using P/EBITDA multiples rather than P/E multiples.

Not quite. Although you may need to make an adjustment for executive compensation expenses, that's not because you are using P/EBITDA multiples rather than P/E multiples.

The market-based approach derives an enterprise value for the firm based on pricing multiples, then allocates that value to the debt and equity holders of the firm. Why do you think you can't simply subtract the face value of the debt to determine the equity value?

Right. The valuation should reflect the current market value of the outstanding debt, which may or may not be equal to the face value, depending on the current interest rate environment.

Not necessarily. While the market value of debt rises as rates decrease, the value of the debt may still be below its face value, depending on the relationship between the current interest rate and the coupon rate on the debt.

Not necessarily. The market value of debt decreases as interest rates rise, and it may or may not be greater than the its financial statement value, depending on the relationship between the current interest rate and the coupon rate on the debt.

Consider a healthcare firm, Norton Healthcare. There is a good group of similar guideline public companies in this industry. Why do you think you should not use P/EBITDA multiples in this approach?

Yes. EBIT and EBITDA correlate to the market value of invested capital (MVIC), which is the value of the firm before debt. So, earnings need to be adjusted to exclude the interest expense from debt, and debt would be subtracted from the MVIC to determine the equity value.

Right. The most important characteristic for the market approach is to find public companies in the same industry as the private company.

Yes. Certain industries use financial metrics that are unique to those industries. These widely accepted metrics would be more useful in a valuation than a standard P/EBITDA multiple.

Not quite. Although size is important, this isn't the first characteristic to look for.

Once you find a large group of companies in the right industry, what additional characteristics should you use to select a group of guideline public companies for a valuation?

Sure. Size and growth are two important characteristics, after industry, in selecting a group of guideline public companies.

No. These may be factors to consider, but other factors are more important at this point in the process.

No. You are not likely to be able to compare the success of specific marketing programs. Generally, there isn't public information available at this detailed of a level.

The market approach is conceptually preferred, and it's also the best approach in certain circumstances. If a valuation is being prepared for an estate tax litigation case, should you use a market approach or an income approach?

No. There's no reason to switch to an income approach solely due to this purpose for the valuation.

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No. If Norton's EBITDA has been growing, it's a good metric to use in the valuation.

Not quite. EBITDA may or may not be unusually low for this industry, but that doesn't explain why the P/EBITDA multiples shouldn't be used.

No. Market presence may be considered much later in the process of selecting guideline public companies. This wouldn't be a good factor to use in the initial search.

Right.

Courts have shown a preference for the market approach due to the fact that this approach is based on actual market price data. In a market-based approach, pricing multiples are derived from the guideline public companies, then applied to the subject company to derive a valuation conclusion. There are numerous different pricing multiples, but the price-to-earnings ratio (P/E) is common. Price/EBITDA and price/EBIT are also used frequently in private company valuations.

When people bungee jump, they want the strongest bungee cord available. Similarly, most people consider the market approach to be the strongest approach conceptually for valuing a private company. Market-based approaches estimate the market value of a private firm by using comparisons of public companies and acquired companies and their market pricing data. The __guideline public company method__ uses the pricing multiples of public companies that are similar to the private company being analyzed to estimate value. The __guideline transaction method__ uses pricing multiples from similar public company control transactions to estimate a control value of the private company.

Adjust for debt

Remove nonoperating assets

Review, and possibly adjust, executive compensation expenses

Size

Industry

US market presence

When interest rates change, the market value of the debt is not equal to the face value

When interest rates decrease, the market value of the debt is greater than the face value

When interest rates rise, debt is worth considerably more than its face amount on the financial statements

Norton's EBITDA has been growing

EBITDA is unusually low in the healthcare industry

The healthcare industry has industry-specific metrics that are widely accepted

Size and growth trends

Depth of management team and variety of products sold

US market presence and success of marketing programs

Market approach

Income approach

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