How to Value a Private Company: Public Comps

Understanding a company’s value is essential for investors looking to make a deal. But for investors focused on the private middle market, valuing target companies can be a huge challenge.

Metrics for comparable public companies — or “public comps” — are one of the most commonly used tools to value a private company from the outside looking in, especially before investors gain access to the company’s full financials.

Additionally, investors typically have an easier time of getting a target company’s top executives to engage and share more if they can give them a sense of what they think the company is worth.

Below, we break down what exactly public comps are, why they matter for private markets, and how investors across industries can put them to use.

What Are Public Comps?

Because their financials are difficult to find, calculating the value of private companies tends to rely on assumptions and estimations. But with a little research, you can find the right set of public comps to use as benchmarks. This can help you develop a more accurate valuation for your private targets.

Public comps are specifically focused on valuation metrics, like enterprise value (EV) / revenue and EV / EBITDA multiples.

Enterprise value is derived from the equity value, which is a public company’s market cap adjusted for net debt.

Why Do Public Comps Matter for Private Markets?

The public markets have many transactions. The daily trading volume for Microsoft alone is around 20M. To put this into perspective, there are around 200 M&A transactions per day in the entire world.

The difference is a factor of a shocking 100,000 — and that’s just compared to Microsoft. Imagine what that looks like across an entire sector, let alone all publicly traded companies.

Needless to say, that’s a ton of data about a company’s valuation, including what sellers of shares are willing to take and what buyers of shares (ie, investors) are willing to pay. This sheer volume tells you how “the market” values a company.

Aside from transaction volume, what makes the public markets special is the transparency of company financials. Sure, you might know how much a share costs and how much a company is worth, but the public comps are only valuable because you have the other part of the equation: the financials.

With public comps data, you get revenue, gross profit, net profit, growth, and other GAAP financial metrics.

While EBITDA is typically used as the best proxy of a company’s interest and tax-adjusted profitability and the second part of the coveted EV / EBITDA multiple, it is not a GAAP metric. Therefore, it is typically not reported by publicly traded companies.

However, investors often make their own assumptions to calculate EBITDA. There are enough sell-side and equity research analysts on the street doing research and talking to management teams that getting a solid sense of EBITDA isn’t that hard.

Ultimately, public comps allow you to see how financial metrics affect a company’s value. You can test sensitivity to top-line growth, bottom-line growth, and profitability — which are critical for determining the value of a private company.

Additionally, they tell you what a private company could (and, for the publicly traded companies that are highly valued by the market, should) look like when it reaches scale. Oftentimes, investors are pitched that a private company isn’t profitable yet but is expected to hit some margin when they have scale. Seeing it in the public markets makes it more believable.

Source: Microsoft via Yahoo Finance

The last important factor here is the ability to track a company, or set of companies, over a long period of time.

In private markets — venture capital, for example — a single company may only raise money once every 1-3 years. In private equity, that can be even more infrequent, as average holding periods are 5-7 years. Recall that Microsoft trades 20M times a day, on average.

This makes it hard to track how the market is trending. Let’s say, for example, that Company X raises $10M at a $50M post-valuation. It sells 3 years later for $150M. From the outside, you have no way of knowing if its multiples have gone up or if the company grew enough under the same multiples. Whereas with a public company like Microsoft, you can see its revenue from 5 years ago and its market cap, so you can discern how differences in performance affect valuation more easily.

This is where public markets are valuable. Being able to track a single company, or a fixed set of companies, over a long period of time helps you understand if you’re seeing inflated, deflated, or historical average valuations.

Source: Aventis Advisors

How to Value a Private Company Using Public Comps

Why Investors Use Median Figures

While we learn discounted cash flow (DCF) models in school, DCFs are rarely used in the industry. They are considered an academic exercise, at best. Comps are widely considered the most utilized valuation methodology because they are reflective of what investors are willing to pay.

Each company has its own nuances and quirks, but when you average across several companies in a comp set, you can get a pretty good sense of how similar private companies would be valued if they were publicly traded.

One important thing to consider is that there will always be outliers that can skew your average. The example below shows public comps for the clean power installation and management sector.

Source: Grata

This is why we often see investors use medians, which are resistant to outliers, when using public comps.

Selecting Your Comp Set

First, you need to pick the right comp set. But finding the right comparison can be tricky — public companies are complex and often have multiple product or service lines. Private companies, on the other hand, tend to be less complex by virtue of their stage.

Identifying the most useful comps can be easier if the public company has an independently operating subsidiary that’s close to the private company you’re evaluating. It’s not always the most indicative of value if that subsidiary is immaterial to the parent company and doesn’t influence its valuation, but valuing a private company isn’t a precise science, and this is often the best you’ll get.

The example below highlights how matching to public subsidiaries also allows the right public comps (owners/parents of those subsidiaries) to appear in for the space tech industry.

Source: Grata

Note that when using public comps, you will almost never need to consider scale as a comp set selection factor, because it will be assumed that your private comp is smaller than its public comp peers.

How Should PE Investors Use Public Comps in Their Models?

PE firms typically do leveraged buyouts (LBOs). If you’re building an LBO model, you want to create a separate analysis — usually on a separate tab — with your public comps. You should calculate your mean and median EV/revenue and EV/EBITDA multiples. Then, add it to two spots in your models:

Entry (EBITDA) multiple: It’s fine to run some sensitivities based on historical volatility or variance within your comp set, but you should start with the median.‍
Exit (EBITDA) multiple: Most firms model the same entry and exit multiples because multiples, while cyclical, tend to converge over the 5-7 year typical PE holding periods. And if you enter at the peak and try to sell at the trough, you often have flexibility to increase or decrease your hold period to minimize the risk of multiple compression. However, if you know you’re going to over/under pay for a company, then it’s OK to adjust your exit multiple back to the current median or 5-year historical average.

Source: Wall Street Prep

Many PE firms are also pursuing buy-and-build strategies where they consolidate industries by “rolling up” many small companies. In this case, each acquisition needs to be modeled with a lower entry multiple than the multiple of the platform on exit, in order for the inorganic growth to be accretive.

Smaller companies in the middle market are often discounted on their valuation due to their lack of economies of scale –- branding, negotiating, pricing power, etc.

Smaller deals (<$100M) also have less debt, according to GF Data. Deals under $50M TEV average debt 3.4-3.6x EBITDA compared to deals >$50M TEV averaging 3.8-4.4x EBITDA. Add-on deals are less financially engineered and therefore less sensitive to interest rate hikes.

Source: GF Data

How Should Growth Equity Investors Use Public Comps in Their Models?

Growth equity is often even simpler than PE, as there tends to be less leverage in growth deals. Growth investors often back companies with little to no EBITDA, and therefore limited capacity to pay off debt.

This is important because growth equity investors will often value companies at entry on a revenue multiple, not on an EBITDA multiple. You can use your median from your public comps to power this multiple.

Similarly, exit multiples can be modeled based on your public comps. Growth equity investors need to be careful here, though, because their investments often need to become profitable during their holding period and may be valued on EBITDA multiples on exit.

This would take modeling the right EBITDA margins for the business first — again, taken from your public comps! Then, you would apply your EBITDA multiple on exit, if applicable.

Do Public Comps Matter for VCs?

Again, yes. VCs aim big. They pay very high prices and expect their portfolio companies to IPO and give them a 10-100x+ return.

Public comps are important for late-stage VCs to model returns. If they’re going to pay high prices in a hot Series C or D company, then they need to expect multiple compression on exit when their investment approaches IPO or goes public.

For example, if you pay 20x revenue for a software company, but you expect it to IPO at 8x revenue, you need 2.5x revenue growth just to break even. This needs to be considered in your models.

Public comps are also important for VCs to figure out what the financial benchmarks of their investment should look like at scale. They need to track this over the lifecycle of the investment to ensure it will get the exit they expect when entering the public markets.

While a VC may sell a portion of its shares at the time of the IPO, there is often an expectation they roll and lock up a significant amount of shares for 1+ years after the IPO to align incentives. For example, if recent IPOs show that unprofitable companies flop, VCs use this information to make sure their portfolio companies are profitable before they go public.

Source: HowMuch.net

Do Public Comps Matter for Corporate Development?

Corp dev teams often report to the CFO and use detailed public comps for quarterly or board level financial benchmarking.

However, public comps are critical for M&A as well. Corporate acquirers can pay what looks like hefty prices for a company and beat out any financial sponsor (or any other offer for that matter) in a process if they find a company is going to be accretive to their value. How so?

Take, for example, the acquisition of a $20M mid stage software startup. The company may be worth 8-12x revenue to a private equity firm based on their analysis of public comps.

But let’s say you (if you’re public) and your public peers (if you’re private) trade at 20x EBITDA. In your acquisition, your cost synergy may be your distribution (sales & marketing) or your tech team (product & engineering).

In this case, you may not need to bear the majority of the cost structure of the startup. Maybe COGS are 10-20% and you keep some of the opex — call it $6M of costs for this example. You now have $14M of that startup’s revenue going straight to your bottom line making you 20x * $14M = $280M more valuable.

And that’s not counting any revenue synergies that would come from better distribution or a better product. So you can pay up to 14x for the company for it to be accretive day 1, potentially even more if you expect disjointed growth. That allows you to win more high quality deals.

How Grata Can Help

If you’re interested in using public comps for private market investing, Grata can help. Our Market Research product, which is powered by our award-winning AI search, helps investors scope any market and find the most accurate deal data and comps so you can win more deals.

With just a few clicks, you can access multiples and market caps to see how your market’s public comparables are valued, along with margins and growth so you have the right financial benchmarks.

And thanks to our proprietary AI algorithms, you can find the right comps even for specific market segments. Here’s an example of public comps for the language acquisition segment of the education tech space, which we covered in a recent PE Playbook:

Source: Grata

You can even generate the closest public comps for a single company. Let’s say, for example, you’re interested in a company like Chalksnboard, a privately-owned online learning platform that uses AI to personalize class material. Simply search for the company and click “Generate Market.”

Our AI identifies similar companies to create the market and the appropriate public comps.