Trading vs. Transaction Multiples

In reality, investors and analysts typically use trading and/or transaction multiples to assess the potential exit value of the company. The table below summarizes some of the key issues that we have to keep in mind when using these multiples. 

 

Transaction multiples

Trading multiples (listed companies)

Definition

Valuation multiples that were paid in recent corporate transactions (trade sale, buyout, etc.)

Valuation multiples we observe for firms that are listed on the stock exchange.

Fundamentals of comparables

Similar transactions (e.g., trade sale) can involve target firms with very different fundamentals (e.g. small and large, young and mature, profitable not profitable, etc.). Comparability?

Listed firms tend to be more mature and somewhat less heterogeneous. Large portion of their value comes from the existing business (assets in place). Survival probability is high. This is atypical for startups.

Value driver

What’s the appropriate value driver? Startups often have low revenues and negative earnings. Standard multiples such as EV/EBIT or the P/E ratios therefore produce meaningless valuations

Validity of multiple at the time of exit

Today’s transaction multiples WILL NOT be valid at the time of exit in 5-7 years!

Better reflect the possible lifecycle stage at the time of exit

Type of securities

Transactions can involve many different types of (equity) securities, including common stock, preferred stock, convertibles, etc.

Usually common stock, possibly multiple classes thereof (e.g., voting, non-voting)

Additional deal provisions

Transactions often include additional potentially valuable provisions such as the right to appoint directors, anti-dilution protection, participation rights, lock-up of founders, etc.

Usually subject to no additional provision. Possibly lock-up provisions shortly after the IPO.

Liquidity

Private transactions are infrequent. Demand and supply can change swiftly. Prices are usually subject to illiquidity discount.

Exchange traded firms are generally liquid investments.

Control

Transactions may or may not change the control of the firm (e.g. >50% of the shares are sold). Control is valuable.

Stock prices typically reflect trades of minority shareholders. Might be subject to minority discount.

Synergy

Transaction prices may or may not include a synergy premium (in the case of strategic deals). Synergy premiums can easily be 30% or higher.

Stock prices typically do not reflect potential synergies between buyers and sellers (unless the company is a takeover target).

Diversification of owners

Different buyers will have different degrees of diversification. This can affect the willingness to pay.

Stock prices reflect investment decisions of well-diversified shareholders. In startups, shareholders are typically poorly diversified!