Breaking Down The Startup Comparable Company Analysis
By Lior Ronen | Founder, Finro Financial Consulting
The comparable company analysis (CCA), also known as the comparables analysis, is essential to business valuation. The CCA is used to evaluate your competitors in order to estimate the company's value relative to its peer group.
The underlying assumption behind the comparable company analysis is that similar companies in similar niches should have a similar valuation relative to their level of revenues and earnings.
In this post, we'll cover the basics of the comparable company analysis:
What is the comparable company analysis?
What should a comps analysis for a startup include?
How to build a comps analysis?
What is the comparables analysis used for?
What is the comparable company analysis?
The comparable company analysis, also known as the comparables analysis, competitors' analysis, or simply comps analysis, is used to understand how a company's valuation is affected by its competitors and how the market values similar companies.
The comps analysis is a list of comparable companies whose valuation and financial information benefit our analysis.
We should include in the list of comparable companies market leaders, peers, partners, direct and indirect competitors, and companies with a similar business model to the company we're valuing.
The longer the list, the better the insights we could drive from it.
For example, including only 5 of the company's publicly traded competitors in a competitive analysis will give each competitor a 20% weight in the final calculation, skewing the analysis toward the performance of publicly traded companies.
For this reason, we'll include both public and private companies in our analysis--even though private companies are more challenging to track down--and we'll also include information about previous deals in the niche or adjacent niches that may be relevant for our case.
Comparables valuation is excellent because it's a valuation model equally applicable to every business, whether a seed-stage startup or a mature, profitable company.
What should a comps analysis for a startup include?
When building a comps analysis for a privately held startup, a different set of criteria should be considered than when making a comps analysis for a public company.
Two essential factors distinguish public from private companies' comps analysis: their granularity level and their information availability.
When building a comps analysis for a public company, investors should include per-share data such as share price, earnings per share, revenues per share, etc.
This data is readily available and can be used to develop insights that can be translated into trading actions.
However, per-share data has no value for a private company, and obtaining per-share data may be nearly impossible.
The primary information in a startup comps analysis includes:
Company name: sounds basic, but knowing the names of each comparable adds excellent value to the reader.
Company symbol: relevant only for public companies and mainly adds context and simplicity to validate the information.
Valuation: We'll use the latest funding rounds' valuation for private companies. For public companies, we'll use the enterprise value (EV). In some cases, where EV is unavailable, we'll use market capitalization instead.
Revenues: For private companies, we'll use the most recent annual revenues we can find or estimate the company's yearly revenues during its latest funding round. We'll use trailing twelve months (TTM) revenue information available online for public companies.
EBITDA: the earnings before income tax, depreciation, and amortization is typically used for public companies only since it's extremely hard to obtain for private companies. Like in the revenue's case, we'll also use the TTM EBITDA.
Beta: In finance, beta, a measure of the volatility of an investment relative to the market, is commonly used in the capital asset pricing model (CAPM), which describes the relationship between risk and return for assets. Beta is a primary component of the company's discount rate (or WACC) used in specific valuation methods.
Market capitalization and debt: The equity and debt ratios are fundamental when calculating their discount rate for a discounted cash flow analysis. The equity ratio is the company's market cap (E) divided by the total enterprise value (TEV), which is the company's market cap (E) plus its debt (D). Since startups are privately-held businesses, they don't have the equity or debt to build these ratios required for the analysis, so we'll use an average ratio of the comps industries to calculate an estimate that could be used in place of those numbers.
How To Build A Comps Analysis?
There are three steps to building a useful comps analysis:
Build a list of comparable companies.
Gather all the required data.
Calculate multiples and averages.
1. Build a list of comparable companies.
To start a comps analysis, you must first prepare a list of potential companies to consider.
A variety of companies should be considered, including public and private firms, small and large ones, market leaders, competitors, leaders in adjacent industries, or just companies with a similar business model.
To keep your valuation from being distorted, consider enough companies.
The top priority is for direct competitors and peers. You should have at least 20 - 25 names on that list.
If you have too few competitors, you can start adding more distant ones. If distant competitors are not enough to beef up your comps list, you can use partners, suppliers, and clients who operate in the same field as you.
If even that wasn't enough, you should break your business into small pieces and find comparable companies for each piece separately. In the end, you will add all the pieces to mimic your exact business model.
2. Gather all the required data.
This is the tricky part.
In the list, you will find some companies that are publicly traded. This means that you can easily find information about those companies on Yahoo Finance or Morningstar, regardless of where they are listed.
This is not the case with private companies.
Information about privately-held companies in our list is the hard part of the research.
Because private companies are not required to disclose their financial information, it is more difficult to gather this data than information on public companies. Harder, but not impossible.
There are three primary sources to gather financial information on private companies' financials:
Press releases: companies tend to release information about their funding rounds, revenue growth, and other significant achievements in blog posts and press releases. They might release this information as a one-time event or as a recurring trend once a year, but it can be helpful for potential investors to keep track of the latest developments.
Media: When they market their startups, startup founders go on the media and, as a form of business promotion, provide financial information to make their stories more colorful and promote the interview. In other cases, startups work with journalists and provide certain information for a story about their startup and even on competitors or specific markets.
Paid platforms: In the year 2022, there is hardly anything confidential. In many instances, financial information on privately held startups can be found on paid platforms like Pitchbook, Capital IQ, and PrivCo. You can argue about the accuracy of this information— which is usually a mix of self-reporting data and aggregating data from different government filings—but the fact is that using these paid platforms is a norm in investment banking and private equity firms.
What information are we looking for anyway?
We should start with the latest enterprise value (EV), TTM (trailing twelve months), revenues & EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), beta, and last 3 years' revenues, CAGR (compounded Annual Growth Rate.
The EV, revenues, and EBITDA will help us in the comparables valuation. The beta will help us in the discounted cash flow (DCF) valuation. The CAGR will help us put everything into perspective.
3. Calculate multiples and averages.
At this stage, we have between 20 to 25 comparable companies on our list, including public and private companies, small and big, from different niches.
Now, we can start driving initial insights and data from the list.
We first calculate the revenues and EBITDA multiples for each company on the list.
To do this, we divide each company's valuation by its total trailing twelve months' revenue or latest annual revenue to compute the EV/Revenue or revenue multiple. In the same way, we divide each company's valuation by its total trailing twelve months' EBITDA to calculate the EBITDA multiple.
You're unlikely to find EBIDTA figures for privately-held companies. Revenue multiples are used instead, and that's fine and expected.
Next, we will group all companies' multiples (and their betas) into an overall average. This can be calculated using either a simple arithmetic mean or a weighted average, where each company receives a different weight. This depends on the case.
What is the comparables analysis used for?
The comps analysis is a powerful and fundamental component in several financial models.
The first place a comps analysis can be used is the comparable valuation method. In this method, we value our company based on the valuation multiples of its peers. The great thing about it is that it could be applied to any company, in any size, niche, status in the private or public markets, pre or post revenues.
The comparable valuation provides a valuable market sense to the valuation process and is easy to calculate, explain, use, and update, making it user-friendly.
The second place a comps analysis can be used is when building the company's discount rate when discounting the company's free cash flow in the DCF valuation.
