Navigating the Complexities of Selecting Comparable Companies for Unique Industry Transactions
As part of the valuation process, one of the most formidable tasks for appraisers is sourcing quality, comparable transactions. This challenge is especially magnified because there are no reporting requirements for privately held company transactions. This leads to transaction databases with inaccurate or non-qualified data, making transaction data even more challenging for unique / niche businesses.
Adopting a Flexible Approach:
The process of selecting comparable companies for unique industries demands a flexible and creative mindset. By broadening your NAICS Code search to include other similar industries, you can overcome the challenges of limited transaction data and deliver defensible analysis for valuations or business listings (for sale) for even the most unique businesses.
Consider the computer manufacturing industry —an industry growing with rapid technological advancements with many of those being niche markets. For example, companies that manufacture digital system panels for the Electrical Contracting Industry. Niche business yes – not likely to find any direct comparisons but that doesn’t mean there are no comparisons at all. You have to dig further.
In this example, we would start with the initial search using the three-digit NAICS code prefix specific to technology manufacturing, which is 334. No surprise that finding transactions closely resembling the subject company's profile proves elusive.
Expanding the Transactions Search:
Recognizing the need to cast a wider net, we may opt to broaden the search to encompass related industries within the broader technology sector. This entails exploring additional NAICS codes, potentially incorporating 5 or even 10 additional codes representing sectors like electronic component manufacturing, circuit board manufacturing, and even measuring / controlling device manufacturing. By doing so, the pool of potential comparable transactions is significantly increased, facilitating a more comprehensive analysis.
Analyzing Comparable Transactions:
Upon compiling the expanded dataset, you have to take a meticulous approach in your analysis, taking into account various factors such as industry dynamics, product offerings, geographical location, and financial performance. Transactions demonstrating sufficient comparability to the subject company are retained for further scrutiny, while those failing to meet the criteria are systematically excluded.
Consideration of Financial Structure:
In the realm of comparable transactions, emphasis is placed on factors such as company size, cash flow margins, and marketability (the more comps the more marketable the industry is), often ignoring industry altogether. Remarkably, instances exist where companies from completely different industries have been deemed comparable solely based on their financial structures, underscoring the importance of a nuanced approach to comparability assessment.
In reviewing your data, remember that while each transaction may not precisely mirror the subject company's profile, collectively, they can / should provide valuable insights into the financial structure, performance metrics, pricing dynamics, and valuation metrics relevant to the computer manufacturing industry. The question of whether a transaction is worthy of consideration hinges on its alignment with the subject company's characteristics and market dynamics. In the end, if the entire sample of comparable transactions is deemed relevant, they should be integrated into the analysis – if not, the market approach receives no weighting in the final valuation conclusion.
At GCF Valuation, navigating the complexities of selecting comparable companies for unique industries requires our staff of appraisers to look beyond the surface characteristics of a company. We train our staff to focus on the underlying factors that render it comparable to others. By embracing a flexible approach without preconceived opinions, and our knowledge of the NAICS system, our appraisers can effectively overcome the limitations of transaction data and provide robust valuations that withstand scrutiny.
As an experienced Business Owner, M&A Advisor or Appraiser, you know the importance of benchmarking your business against peers to understand its true value. However, accessing accurate and up-to-date data on peer businesses can be a daunting task. Traditional methods, such as scouring public databases or relying on industry reports, often yield incomplete or outdated information. This leaves you with a significant blind spot when trying to determine a business's worth.