Market Comparable Analysis for Corporate Valuations

One of the most common questions business owners ask when exploring a sale or capital raise is: “If similar public companies trade at 15 times earnings, why is my company worth only 4 or 5 times?” The answer lies in a set of structural valuation discounts that apply almost universally to privately held businesses — discounts that market-comparable analysis must account for to produce a credible number.

Why Market Comparables Matter — and Where They Fall Short

The IRS provides some valuable insight to the important issues in valuing companies which Deal Capital's philosophy closely follows (value is a prophesy of the future which requires an understanding the Company, industry, economy and future potential of the Company). In addition the IRS strongly emphasizes/encourages the use of market comparisons which we have not used significantly in the past.

Their are significant structural differences between the public market of large corporations and privately held business that make such comparisons very questionable. However, many of our clients are used to hearing P/E ratios of comparable traded companies which we need to be able to explain. Following is a brief listing of reasons why our valuations will typically result in P/E ratios from 3 to 6 times while public companies may trade from 10 to 20 times.

A History vs. Base Year — P/E ratios of public companies are typically based on the last year of history while clients will tend to focus on the base year or year one when calculating their P/E ratio.

Marketability Discount — The lack of liquidity significantly reduces value. Studies of sales of restricted stocks in publicly traded companies and stocks of private companies that subsequently went public sold for discounts ranging from 42% to 74% of their public counterparts (see “Valuing a Business — The Analysis and Appraisal of Closely Held Companies” chapter 10 by Shannon P. Pratt). While the transactions in these studies related to restricted/unregistered stock the purchaser likely knew that the stocks would be freely trading in the near future as restricted stock are generally restricted for a limited duration and the unregistered companies went public in the near future. As many of our clients are not prime candidates for a public offering in the near future the prospects of future liquidity are lower which should result in a marketability discount higher than these studies.

Diversification/Size — Public companies are generally significantly larger and more diversified than our clients. This diversification and size significantly reduces the level of risk and consequently allows for a higher multiple for the public market. Diversification includes geographic territory, products and customers.

Organizational Structure — Public companies due to their size typically have a strong management structure in place. Conversely, many privately held business are highly dependent on the owner and have a lean organizational structure which tends to make them highly dependent on a few key individuals.

Comparability — Are companies really comparable? Is the asset structure, degree of leverage, management structure, etc. really comparable? By comparing the P/E ratio of a public company in the same SIC code without giving consideration to all of the other factors that effect risk/value the individual is blindly assigning value.

Cost To Go Public — The discount for lack of liquidity should at a minimum be equal to the cost of going public for a company that is a candidate for a public offering and higher for a company that is not a candidate. Cost of a public offering can easily range from 15% to 25%.

The number of reasons why our values will typically be lower — The number of reasons why our values will typically be lower than the value of publicly traded companies is endless. However, the above list points out that it is not unusual for a private company to sell for 25% to 50% of public counterparts.

This is sometimes even less, especially when middle-market multiples are depressed.

A Practical Framework for Applying Comparables Responsibly

Even with these structural limitations, public-company comparables remain a useful reference point — provided they are used as one input among several rather than the sole basis for a value conclusion. The most defensible approach layers market comparables with transaction comparables (actual M&A deal multiples for private businesses) and an income-based method such as discounted cash flow analysis. When the three methods produce a range, the analyst can triangulate toward a supportable conclusion. For a deeper look at how those methods interact, triangulating business valuations based on market multiples walks through the mechanics.

When selecting public-company peers, the following screening criteria tend to produce more meaningful comparisons:

• Revenue scale: Restrict the peer set to companies within a reasonable revenue band relative to the subject company. A $5 million EBITDA business should not be benchmarked against a Fortune 500 conglomerate.
• Business model alignment: Same SIC code is a starting point, not a destination. Look for companies with similar gross margin profiles, customer concentration, and revenue predictability.
• Capital structure: Normalize all multiples for differences in leverage. Enterprise value-to-EBITDA is generally more comparable across companies than P/E, because it is leverage-neutral.
• Geographic and market exposure: A company with 90% domestic revenues is not a clean comp for a multinational with global distribution.

How Discounts Are Quantified in Practice

The discounts described above are not arbitrary — they follow recognized valuation methodologies that courts, the IRS, and sophisticated buyers apply consistently. The two most commonly applied discounts to private-company valuations are the discount for lack of marketability (DLOM) and the discount for lack of control (DLOC).

The Shannon Pratt studies cited above are among the most widely referenced sources for DLOM benchmarks, but practitioners also use option-pricing models and restricted-stock studies to support their conclusions. The appropriate discount magnitude depends heavily on the specific company's circumstances: how transferable its business is, whether there is a defined exit timeline, and whether there are contractual restrictions on transfer.

Understanding these mechanics matters enormously for owners preparing to sell. The top value drivers in exit valuations — things like recurring revenue, management depth, and customer diversification — are precisely the factors that narrow the gap between public-market multiples and private-company transaction values.

Business owners who want to understand where their company sits on that spectrum before going to market can use the due diligence tracker to systematically document the factors that buyers and appraisers will scrutinize. Getting that picture clear early almost always produces a better outcome at the negotiating table.

Frequently Asked Questions

Why do private companies typically sell at lower multiples than public companies in the same industry?

Several structural factors combine to produce lower private-company multiples: lack of marketability (no liquid trading market), smaller scale and less diversification, management concentration risk (often one or two key people), and the cost and uncertainty of any future liquidity event. These factors are not negotiating positions — they are recognized valuation adjustments supported by empirical research and IRS guidance.

Is the P/E ratio the best multiple to use when benchmarking a private company?

For most private-company comparisons, enterprise value-to-EBITDA is more useful than P/E because it is unaffected by differences in debt levels and tax structure. P/E can be misleading when the subject company has significant owner compensation adjustments or non-recurring items that distort reported earnings. Always normalize the financials before applying any multiple.

How can a business owner increase the multiple they receive in a sale?

The factors that command higher multiples are largely the same ones that reduce valuation discounts: recurring and predictable revenue, a management team that does not depend entirely on the founder, customer and product diversification, and clean financial records. Addressing these well in advance of a transaction — rather than at the letter-of-intent stage — gives buyers less room to apply aggressive discounts. The transparent business valuation framework offers a practical starting point for assessing where gaps exist.

What role do intellectual property and intangible assets play in comparable analysis?

Intangibles — patents, proprietary software, brand, customer relationships — can significantly affect both the selection of comparable companies and the appropriateness of applying standard multiples. A business with strong intellectual property in M&A contexts may command a premium that a pure earnings-multiple analysis would miss. Appraisers often value intangibles separately and add them to the going-concern value derived from income or market approaches.