This is the third in a series of comments on the use of valuation multiples. All three comments are posted on the website.
In our last commentary, we looked at the impact of company size on business value. While a small company’s earnings may be inherently riskier than large public companies, we often find that the company growth rate can be much larger for small private companies. A higher growth rate results in a higher valuation multiple, which helps to balance any decrease in value caused by the risk of being a small company. An adjustment to the size calculation (similar to that described in our last commentary) can be made to reflect the difference in growth rates between a public company multiple and a comparable private company. An example of the impact a change in growth rate has on a valuation multiple is shown below.
A 2% increase in the long-term growth rate of the company, increases the value of the company by more than 20%. Additionally, adjustments (discounts/premiums) must also be made to the private company value to reflect differences related to the level of marketability and control between the comparable public companies and the private company. The ability to quantify and justify the economic differences between large public companies and small private companies typically results in a significantly different value for the small private company.
At PW&Co, our expertise in valuation allows us to advise clients on valuation issues in connection with the sale of companies and their assets and informs our advice on the process by which they are sold. All of these factors work together to achieve the best execution. When selling an entire company, we advise clients to look for synergistic and industry buyers who can realize the greatest benefits from the acquisition, and thus pay the highest price for the company.