You may have heard of comparable sales (comps) before in the context of buying or selling a home. Comps are a highly valuable tool to find the value of a home or a business.
One of the first steps in planning to sell your business is to get a business valuation. If you get a valuation through a business broker or valuation company, they will use comparable business sales to support their value conclusion.
At MidStreet, we use comparable sales databases daily to help business owners understand the market value of their most important asset.
To give you an idea of how comps work we will go over how to find them, what information they contain, how to identify good ones, and what you can do if you can’t find good comps for your business.
Let’s jump in.
How Comparable Sales Work in Business Valuation
For this blog, we will be speaking in terms of private comparable sales, rather than public comps. Private comps are comparable sales of privately held businesses in the United States.
A comparable sale, or comp, is a set of facts about a business that recently sold. It might have similar characteristics to your business including:
- Size - When searching for comps of a similar size, you will start with the SDE / EBITDA, and then compare revenue. For example, if you own a pest control business doing $500,000 in Seller’s Discretionary Earnings, you’ll want to search for comparables in the range of $400,000 to $600,000 to start.
- Industry - It is best to get comps in the same industry or very closely related industries. You will want to make sure you get comparables of a similar service type (maintenance versus installation).
- Geography - Comparables are ideally in the same state or region of the country, but can be national if few quality comps exist. Location is not as important as industry or size in most cases.
Other characteristics may be considered when selecting comps, but size, industry, and geography will have the most impact on value.
How Are Comps Found For a Business Valuation?
Comparable sales are gathered from databases such as:
- PeerComps - Smaller deals, typically SBA 7a financed deals
- BizMiner - Smaller deals, typically SBA 7a financed deals
- DealStats - Larger deals including public companies
These databases receive information from banks, business brokers, and M&A advisors that report data on their completed transactions. This inherently introduces the possibility for data to be incorrect, since information may be reported differently.
The sales in most private small business databases come from SBA lenders or business brokers where the business was acquired using an SBA loan. Sometimes they put in information with a different definition so you’ll want to sanity-check the numbers.
For example, if you look at the comparable's EBITDA and SDE and there is a huge difference then you can be fairly certain the data is not accurate. EBITDA and SDE should generally be within $100,000 - $250,000 of each other.
What Is Typically Included in Comps in Databases?
Comparable sales databases will usually include the following information for their comps:
- Sales price
- Annual gross revenue
- SDE and EBITDA
- Profit margins
- Multiple of Revenue (Price/Revenue)
- Multiple of SDE (Price/SDE)
- Multiple of EBITDA (Price/EBITDA)
- The state and the year the sale occurred
- The value of the business’s assets
The value of the business’s assets can be useful but be sure to take it with a grain of salt. Some brokers input the book value of assets while some input the fair market value of assets.
How Are Comps Used in a Business Valuation?
Comparable sales are used to gauge the current market value of the type and size of business being valued. It will help the valuation specialist determine what multiple to apply to the SDE or EBITDA.
It won't provide them with a definitive number, but it will give them a range to work with. From there, they will adjust the multiple to fit your business.
For example, if the business being valued (the target) is an owner absentee business, you have to adjust the multiple higher. Owner absentee businesses are highly desirable to potential buyers.
Another factor that could increase the multiple is if the business has recurring revenue. This is a highly valuable attribute because it is a steadier stream of revenue that the new owner will be able to rely on.
What Do You Do If You Can’t Find Good Comps?
If a valuation specialist can’t find any comps that match the target business they are valuing, they will take the criteria listed above (size, industry, and geography) and work backward.
The analyst will start by broadening the geography of the comps, then the industry, then the size. They will find businesses of a similar size, potentially larger or smaller, and then adjust the multiple.
Say you own a business that is one of only 3 or 4 firms in your state to perform a particular niche B2B service. You might start by looking in your state and the surrounding ones.
It is likely there are no direct comparables in your area, so the best course of action is to expand your search area and look regionally (Southeast), then nationally. If this still doesn’t turn up any comparables, it’s best to expand the size range.
If you still can’t find a good comparable (which happens often with very niche businesses) it’s best to reset the size and geography parameters back to mirror your company and look in adjacent industries with similar business models.
For instance, if your company helps businesses perform a niche manufacturing process, you might look for other companies that also specialize in niche manufacturing.
Know How The Value of Your Business is Calculated
Now that you know what comps are, how they are found, and how they are used in business valuation, you have a better idea of how businesses are valued.
The next step in understanding how to value a business is to learn about business valuation in general. To find out more about business valuation, read “What is a Business Valuation? (And Which Type Is Right for You).”