Business Valuation: The Market Value Approach

Business valuation is one of the most important processes that you will have to face at least once in your business lifecycle. This situation can come up mostly when you are about to raise funding for your business. That is when you need a person to help you get the value of your business so investors can get the right amount of shares of your business in exchange for the funds they provide.

And you might be thinking that getting the value of a business is pretty simple; all you need are some accounting figures from your company’s financial statements. But this is not true. There are a lot of things that come into consideration when you want to value a business. One such thing is selecting the right valuation method. Out of the many approaches to value a business out there, the market value approach business valuation method is most suitable when comparing to other companies in the industry.

Market Value Approach to Business Valuation

The market value approach to business valuation is a process where a value is assigned to a business based on market forces in comparable situations. The comparable situation here can be either a prior transaction involving the same business, an ownership transfer transaction involving a comparable (public or private) company, and/or a market quote of listed securities of a comparable public company.

The price multiple is then multiplied with the relevant financial metric of the business being valued to arrive at a valuation estimate. Based on the source of comparable valuations used, the market value approach is further classified into two methods which have been explained below in detail.

How the Market Value Approach Works?

Just as the name says, the market approach to business valuation method looks to answer one question, which is: “What is the fair market value of this asset?” To get the answer to this question, the valuation has to survey recent transactions that involve similar assets. Additionally, since these assets are unlikely to be identical to the one that is being valued, a lot of adjustments would have to be made.

The main advantage of the market value approach is that it is based on publicly available data on comparable transactions. Due to this, it would need a fewer number of assumptions as compared to the other approaches.

Applications of Market Value Approach

Figuring out the value of your business using the market value approach for business valuation is most suitable in the following situations:

• When you want to justify the value of your business when there is a dispute such as a buyout or partner disagreements.
• When there is a need for you to defend the valuation of your business before the tax authorities or in a legal dispute.
• When you want to set the offer price or asking price for a business purchase.

Example of the Market Value Approach

Let us take a real estate example to understand this approach better. Assuming that you are in the market to buy a new apartment. You see a listing for an apartment in your preferred neighborhood being offered for $200,000. This apartment that you are looking at is a 1,000 square-foot apartment with one bedroom and one bathroom.

Additionally, this place is in good condition and only needs some minor renovations. Even though it is in a desirable neighborhood, its view is obscured and it does not have a built-in washing or drying machine. And although you like the apartment, you feel that the price of the place is too high. With the apartment listed for over a month, you feel the price is not at market value, and the seller may accept some negotiations.

Now that you have all the details for the house with you, you set out to get the fair market value in order to negotiate the price with the owner. For this, you will have to look at similar apartments in the same neighborhood.

The details of various deals are in a table as below:

As mentioned earlier, the market value approach relies on the data from comparable transactions. And with the results gathered in the table above, you can begin to draw some conclusions. To begin with, you will be able to see the apartments’ price per SF ranges between $135 and $275. The higher price belongs to those with more bathrooms and bedrooms, built-in appliances, better views, and no need for renovations.

Compared to these, the apartment that you are about to buy is priced at $200 per square feet and has fewer of these features than even the cheapest priced apartment. This seems to justify your intuition that the apartment should have a lower price. And with all this research, you decide to make an offer of $150,000, which is then accepted by the owner.

Market Value Approach Methods

Now that you are clear with what the market value approach business valuation method is about, let us talk about the different types. There are many kinds under this as well based on the source of the known values that are used as guidelines. But we are going to talk about the two main types that are used most. These include:

1. Public company comparables method

In this method, the valuation metrics are used from publicly traded companies, try to make these companies are rightly similar to the subject entity. For most circumstances, direct comparability is hard to attain as most of the public companies are not only big but also more dissimilar to the subject company.

Direct comparability can be achieved in comparatively few industries. A lot of them are faced with differences existing between most private enterprises and public operators.

Basically, the process of choosing, modifying, and implementing public company valuation data is normally complex and requires notable experience and appraiser skill. The guideline companies are normally publicly traded companies in a similar or equivalent industry as the subject company.

The Comparable Public Companies must be identified at the first stage of the Public Company comparison method.

Example of Public company comparables method

Based on the existing information of the comparison companies in the Food-snack and breakfast Industry for the Valuation of WK Kellogg Inc., the following are the metrics:

Calculate Valuation Multiples:

Determine Average Multiples:

Apply Multiples to the Target Company:

The value of WK Kellogg Inc. may be between $3.7 B and $7.6 B (EV) and $3.5 B (Market Cap), using the Public Company Comparables Method.

2. Precedent Transactions method

This business valuation method is based on the perception that the comprehensive company’s financial data is not easily available but there is the availability of the transaction value.

Precedent transactions can be analyzed via the conventional industry classification methods, such as SIC codes. In addition to this, there are many valuation databases that can be tested for evidence of historical actuals and valuation. These kinds of transactions might represent a large or small perspective.

A good guideline transaction needs to be from a very comparable company in the same industry. If there isn’t any direct comparability, other data available can be used. But it cannot be used before considering such things as their products and market.

The initial step involves identifying precedent transactions.

Example of Precedent Transactions method

We take an example again to value WK Kellogg Inc. from the assumed precedent transaction values, involving the food-snack and breakfast industry, we will calculate the value for WK Kellogg Inc.

Next, we will use the data from the above table to calculate the transaction multiples.

* Assuming EV = Market Cap

Calculating the Average Transaction Multiples below:

We will now apply the Multiples to WK Kellogg Inc.

WK Kellogg Inc. could have an implied enterprise value between $2.9 B and $5.7 B, and its market capitalization could be around $3.7 B, using the Precedent Transactions Method.

Steps for the Comparable company analysis

Here are the key steps involved in performing a comparable company Analysis:

Step 1: Find the right comparable companies

The very first thing that an analyst will have to do is look for the company they are trying to value. This will allow them to get a detailed description and industry classification of the business.

After this, the person would have to search databases for companies that have similar characteristics and operate in the same industry. The closer the match, the better. The analyst will have to run a screen based on the following criteria:

• Margins and profitability
• Growth rate
• Size (revenue, assets, employees)
• Geography
• Industry classification

Step 2: Gather financial information

The next thing that the analyst needs to do after finding a list of relevant companies is to gather their financial information.

The information that you will need here would vary based on the company’s stage in the business lifecycle and industry. For companies that are highly mature, you will have to look at metrics like EPS and EBITDA. But for early-stage companies, you might have to look at the gross profit or revenue of the companies. In case you do not have the access to the expensive tools like Capital IQ or Bloomberg, you will have to gather the details manually from their reports, which may be time-consuming.

Step 3: Calculate the comparable ratios

The ratio needed in the table includes:

• P/E – The Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock price and earnings per share (EPS). It shows the expectations of the market and is the price you must pay per unit of current earnings (or future earnings, as the case may be).
• EV/EBITDA – EV/EBITDA is a ratio that compares a company’s Enterprise Value (EV) to its Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA).
• EV/Gross Profit – Enterprise to Gross Profit ratio is obtained by dividing its enterprise value (equity plus debt minus cash) by its annual gross profit.
• EV/Revenue – Enterprise to revenue ratio is obtained by dividing its enterprise value (equity plus debt minus cash) by its annual revenue.

Step 4: Apply multiples to the target Company

Apply the median or mean multiples derived from the peer group to the corresponding financial metrics of the target company. This will yield an estimated value for the target based on market comparables.

Step 5: Conduct sensitivity analysis and combine with other valuation methods

Perform sensitivity analysis by varying key assumptions like growth rates and profit margins to understand their impact on the valuation.

Integrate findings from CCA with other valuation methods for a comprehensive view of the target’s value.

Market Value Approach: Discover Your Business True Worth!

With everything we have covered on what the market value approach business valuation is all about, you now know how this method can help you in getting the value of your company. Keep in mind that this valuation process can only be used if there are similar companies that can be used for comparison. This means that if your company is a small sole proprietorship, using this valuation method may not be right. In such a case, you will have to use the other available valuation methods, such as the income-based approach. Learn more about it here.

And before you get into the valuation of your company, remember that you need to have a proper cap table to help the analyst get the right business valuation done. If you want some help with this, Eqvista is a great app to use.