Using the market approach, appraisers use comparable guideline companies to help reach an estimate of the value of a business. It has become a long-standing valuation touchstone. There are two primary valuation methods that fall under the market approach:
- Guideline public company method. With this method, appraisers select companies that actively trade stock or partnership interests in publick markets, such as the AMEX or NYSE. The appraisers then figure out important financial variables using the stock price and various pricing multiples.
Sometimes these variables are calculated for a specific time period, such as the preceding year, or an average of the last several years. The appraiser uses their professional judgement to figure out the appropriate time period.
Because the guideline public company method is based on individual stock prices, sometimes circumstances it generates a minority, marketable basis of value.
2. Merger and acquisition (M&A) method. For guideline transactions under this method, appraisers look at sales of entire businesses. So this technique typically generates a controlling, marketable basis of value.
Private businesses are not required to let the SEC know when they are sold, so it can be a challenge for appraisers to find out the details of these sales. Fortunately, they do have access to different proprietary databases that they can use to analyze private deals.
Once appraisers have found a good sample of potential guideline transactions, they can then figure out pricing multiples relative to key financial variables.
Deciding Which Way to Go
One of the biggest factors in whether or not an appraiser uses the market approach is the availability of transaction data. Companies that focus on a single target market or offer a limited menu of products may be hard to come by in the public markets. Some industries lack a meaningful sample of transactions, especially if they involve small niche companies.
In general, the guideline public company method makes more sense if the business is large enough to consider going public. Using this method to value a controlling interest may require subjective adjustments for control.
Conversely, the M&A method is generally more appropriate when valuing controlling interests. But, with proper adjustments and analyses, it can be used to value minority interests.
Some other disadvantages of the M&A method could be:
- Limited information about guideline companies from transaction databases.
- Sometimes the details provided about transactions are not verified.
- There could be undisclosed terms in the sales price.
A common valuation mistake is when the appraiser fails to adjust the financial statements of the business to ensure accurate comparison. An example of these kind of adjustments are nonrecurring items or discontinued operations.
Inconsistent terminology may also lead to problems. Slight differences in the ways databases or appraisers define terms can trigger significant valuation differences. It’s imperative to understand how each database defines variables as well as what’s included (or excluded) in the selling price.
An Accurate and Defensible Valuation
The market approach has intuitive appeal: The value of an investment should be comparable to similar investments in the marketplace. However, it’s not as easy as it seems to find reliable comparable transactions. Filler & Associates knows how to apply the market approach to get an accurate and defensible valuation