PitchBook blog

This article originally appeared in our market brief, Why a lack of private market data exposes investors to more risk, which explored how overlooking private market data can create blind spots when calculating valuations, sourcing deals and tracking market trends. 

To price a deal, an investor has to first value a company. 

In order to value a company, assumptions have to be made. That’s the challenge of the task—especially when a company is privately held. With so many variables at play, it’s easy to see why pricing a deal can be difficult to do.

Aswath Damodaran, Professor of Finance at New York University Stern School of Business, has spent decades of his professional life on this topic—and is recognized as one of the foremost experts on corporate valuation.

In the second edition of his book, The Dark Side of Valuation, Damodaran writes about the difficulties of valuing a private company. For one, it is much easier to find data on public companies, multiples and deals.

“In fact, for analysts who do not have access to private transaction data, this is the only option when it comes to relative valuation,” he writes. “The peril, though, is that we are extending the pricing lessons we learn from looking at more mature, publicly traded firms to a young, private business.”

With that in mind, it’s important to identify what kinds of information will provide the insights needed to make the right assumptions to price a deal accurately.

How solely relying on public market data can result in mispriced deals

Investors often use public market comparables to determine the value of a company in their portfolio. Although private and public companies can share characteristics, they also differ significantly. Consequently, these differences affect the underlying value of a public company and create an imperfect comparison for valuing a private company.

To start, public companies are typically much bigger than private companies. They’ve also had time to sort through growing pains, mature in the market and stabilize. This stability, whether gained through a proven business model, diversified streams of revenue, established consumers or beyond, causes public companies to behave much differently than a younger private company.

Because public companies are more established, they often have lower growth prospects—which influences its fundamentals and the multiples paid for by investors. Furthermore, companies that go public should have a greater chance of surviving than a younger company, and therefore trade at higher market enterprise values.

Ultimately, public market data can’t provide the apples to apples comparison that private market data is capable of. The less similar the comparison between companies, the higher the risk of mispricing a deal. Further, overpaying for a company jeopardizes the returns an investor could realize upon exit.  

The ability to determine an accurate valuation—and have confidence about the number—sets an investor up to make better investment decisions.

Determining more accurate valuations with private company data

Overcoming the difficulty of calculating a valuation—and mitigating risk in an investment—starts with having the right level of information to be confident in your deal terms.

Comparing private companies in a similar growth stage and industry can provide more clarity than a public market comparable—especially with access to a large amount of valuation data. That’s why extensive private market data, including EBITDA, pre- and post-money valuations, multiples and deal sizes, are important.

Take private equity for example.

PE firms are sitting on vast sums of dry powder with the growing need to invest. And with so many large players in the industry, transactions are likely to receive multiple offers as GPs bid aggressively to win price auctions.

Further, buyout multiples have been on the rise in recent years across all major geographies and deal sizes. In the first three quarters of 2018, the median buyout multiple sat at a lofty 10.3x. With that in mind, PE firms must be as discerning as ever when it comes to price.

Within a competitive landscape, proper due diligence founded in private market data can protect against overpaying for a deal. Not only does richer data help with valuing a company, it also helps plan the best time to exit and sale price.

With private market data, strategic investors can develop exit scenarios for different windows of time. According to McKinsey Global Institute, this enables them to weigh their options quickly over the course of the investment or hold through the cycle—and be ready to pull the trigger at the right moment to maximize returns.  Download now