Valuing a Company Using Market Data

Key Takeaways:
  • Comparable company analysis estimates value using recent sales of similar businesses and key financial ratios.
  • Analysts filter transactions by industry, size and type to ensure relevant comparisons.
  • Final value is adjusted for cash, debt and non-operating assets to reflect true market worth.

 

If you were to sell your business today, how would you determine its worth? It’s not just about revenue—it’s about understanding how your company compares to others in your industry and what buyers are willing to pay. That’s where comparable company analysis (CCA) comes in. 

Within each business, there are products and services offered that comprise the revenue streams of the entity. The company’s industry is based on their SIC and NAICS codes, defined below, which classify the company based on their revenue streams. If there are multiple industries that the company serves, we may expand the search criteria to those additional industries.  This information is crucial when the company is being valued.  

Valuation analysts typically rely on three main approaches to determine a company’s worth: 

  1. Income Approach – Focuses on projected future earnings, using methods like discounted cash flow (DCF) analysis. 
  2. Asset Approach – Evaluates the company’s tangible and intangible assets, subtracting liabilities to determine net asset value. 
  3. Market Approach – Compares the business to similar companies that have recently been sold, using market data to determine value. 

The market approach is one of the most greatly emphasized approaches in the fair market value world, since fair market value is supposed to be derived from actual transactions. Within the market approach, the analysts perform something that is called comparable company analysis.  

How Comparable Company Analysis (CCA) Works 

CCA is an approach from which the value of the company is determined using ratios and metrics from similar companies in the same industry. CCA is very commonly used in the market approach method, specifically in both the Guideline Public Company and Guideline Transaction Method.  

  • Guideline Public Company Method – Compares the business to publicly traded companies. 
  • Guideline Transaction Method – Compares the business to private companies that have been sold. 

For small and mid-sized businesses, the Guideline Transaction Method is often the most relevant because it includes sales of private companies, which are more comparable than large, publicly traded corporations. However, it can also include transactions involving public companies when applicable. 

But how do we get from knowing how the company performs in their respective industry to determining a value?

Step 1: Identifying, Filtering, and Refining Transaction Data 

The first step in a valuation is selecting companies that are truly comparable to the subject business. Once comparable businesses are identified, valuation analysts pull transaction data from industry databases and refine it based on criteria such as: 

  • Industry – industry classification codes help determine which industry a business falls under. This classification is usually pulled from tax returns or assigned based on conversations with management. Choosing the correct classification ensures the valuation is based on relevant data. 
    • For example, if your company is a commercial HVAC and plumbing business, it would not be appropriate to compare it to a residential HVAC business, since their operations, pricing models and client bases are different. 
    • Industry classification codes are provided by:  
      • NAICS Code (North American Industry Classification System)  
      • SIC Code (Standard Industrial Classification System) 
  • Transaction type – Transactions are provided as either an asset or stock transaction. These two transaction types indicate the type of sale that the company went through, and what was included in that sale. Stock sales are where the entire company was sold, whereas asset sales generally consist of inventory and fixed assets, such as equipment.   
  • Sale date – Typically, transactions within the last 3-5 years are used to reflect current market conditions. However, some practitioners use 10 years of data. It depends on the number of transactions available. 
  • Financial metrics – Revenue, profitability and other key metrics are considered to ensure transactions are similar in size  

For instance, if the company generates $10 million in revenue each year, it is probably not comparable to a company that generates under $1 million in revenue per year. 

Step 2: Analyzing Key Financial Metrics 

Once the transaction data is gathered, analysts extract key financial figures from each comparable company. The most commonly used metrics include: 

  • Net Sales – Total revenue before expenses. 
  • EBIT (Earnings Before Interest & Taxes) – Measures profitability before financing costs. 
  • EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) – A widely used measure of cash flow. 
  • SDE (Seller’s Discretionary Earnings) – EBITDA plus the owner’s compensation for one owner, commonly used for small businesses that are sole proprietors. 

Each transaction provides financial multiples, such as: 

  • EV/Revenue (Enterprise Value to Revenue) 
  • EV/EBITDA (Enterprise Value to EBITDA) 
  • EV/SDE (Enterprise Value to Seller’s Discretionary Earnings) 

For example, if HVAC businesses commonly sell for 3x EBITDA, and your company has an EBITDA of $2 million, then its estimated value using this method would be $6 million before adjustments. 

Step 3: Identifying Market Trends and Outliers 

Once the data is collected, a valuation analyst may use scatterplots and statistical analysis to: 

  • Identify trends in the data. 
  • Remove outliers that don’t reflect typical valuations. 
  • Determine whether certain multiples correlate more strongly with value. 

If a particular multiple (e.g., EBITDA multiple) is widely used by business brokers and M&A professionals in your industry, it will likely have a higher correlation when determining value. 

Adjustments to the Market Valuation 

Once the multiples are applied to the subject company’s financials, adjustments are made to reflect real-world conditions. These adjustments account for factors such as: 

  • Cash and accounts receivable – Cash and accounts receivable are generally retained by the Seller. 
  • Non-operating assets – Real estate or investments that aren’t essential to the business are generally not included in the Company’s purchase price to compute the valuation multiple. 
  • Interest-bearing debt – Any outstanding debts are excluded from the purchase price. 

After these adjustments, the Market Value of Invested Capital (MVIC) is calculated. MVIC represents the total value of the business, including both the market value of equity and debt. 

Next Step: Get a Clearer Picture of your Company’s Value 

If you’re thinking about selling your business or raising capital, understanding how buyers determine value is important. Here’s what you should focus on: 

  • Maintain clean financial records – Buyers want transparent, well-documented financials. 
  • Understand market multiples – Know how your business stacks up in terms of revenue and profitability. 
  • Address operational risks – Reducing reliance on a single owner or key customers increases value. 
  • Transferable value – a delineation can be made between what is considered financial value and transferable value. Financial value is the value the company has to you as the owner. Transferable value is measured by what investors look for and find attractive, such as risks, earnings, and growth. Potential buyers care about transferable value so that when making an acquisition, there is little interruption to the operations of the company. 
  • Plan ahead – Valuation should be an ongoing process, not just something you do when selling. 

Calculating business worth isn’t just about a number—it’s about understanding how buyers see your company and what factors influence its worth. 

If you want a professional valuation or have questions about how your business compares to others in your industry, contact an Adams Brown advisor.