In today’s competitive marketplace, a business valuation is a must-have; and among the methods for such analyses, the business valuation market value approach offers the most real time data.

While a comprehensive business valuation and subsequent report are essentially needed at least once in the lifecycle of your company, experts suggest you should get one more frequently. 

In fact, even under normal circumstances, it makes sense to get a company valuation once every year and a detailed forensic accounting every two years. 

Further, if there are more recurrent changes in underlying market conditions like shifting industry patterns, a change in the economic climate, etc., then it’s better to go for more annual valuations. 

Wondering why you need a valuation so often? 

You see, a business is required to undertake a lot of macro-level activities like attracting investments, raising funds via stake sale or merger, acquisitions, and more. And for all such transactions, a valuation report up to a year of its date of finalization acts as the basis. 

Similarly, with multiple annual valuations, you’ll be able to keep your company’s value up to date even under fast changing market dynamics. 

Now, coming to the techniques of business appraisal, the market valuation approach derives a precise value by comparing your company with businesses of similar size and type. And though other valuation methods are also reliable, this approach helps derive accurate data under present day situations. 

How? 

Let’s dive in and have a look. 

What is the market value approach to business valuation? 

Simply put, a market value approach in business valuation assigns a fair market value to a company based on a comparison either with businesses in the same sector or largely similar ones. 

Herein, a value will be assigned to your business based on the market forces in a fairly comparable situation. And the comparable circumstances can include the following: 

1. One or more previous transactions pertaining to the same business. 
2. Single or multiple ownership transfers involving similar firms (both private and public). 
3. The total market value of listed securities of a comparable public entity. 

The price multiple thus derived from the above will be further multiplied with the applicable financial yardstick of your company to finalize the valuation estimate. Also, based on the comparable valuations’ source, a market valuation method can be further classified into two sub-categories or methods, something we’ll see later.

Talking about the utility of market valuation, this business evaluation approach comes in handy for assigning a value to your company in comparison with similar firms or entities. As such, you can have in-depth know-how as to where your firm stands when compared to the competitors, which will help you with both internal reviews and external transactions. 

Impressive, isn’t it?

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How does a business valuation approach involving market value work? 

As the name suggests, a market value approach to business valuation seeks to answer the question of what is the precise fair market value of an entity. 

Towards that end, this business evaluation method analyzes all the latest transactions involving comparable assets of similar businesses. 

And while it may sound straightforward, the market approach to valuing a business is actually quite complex. That’s because the comparable assets being evaluated are least likely to be identical, and that calls for significant adjustments and pre-valuation analyses. 

When should you go for the market approach? 

Among all the methods of business valuation, the market value approach is the only method relying on publicly available comparable data. And that means this method doesn’t rely on assumptions, as is the case with other valuation approaches. 

For these reasons, the market approach turns out to be the go-to solution in the following scenarios: 

1. In situations like partner disagreements or buyout disputes, the market approach offers a realistic justification of the value of your company. 
2. When it comes to defending the valuation of your firm in a legal dispute or litigation involving tax authorities, this method offers the best way out. 
3. Real time market data can be the best bet if you’re looking to set an offer price for your business or its shares. Also, you’ll find the approach handy when seeking to find the asking price for buying a business. 

What are the twin methods used for business valuation under the market value approach?

Even though there are multiple methods that can be deployed for a fair business valuation using the market value approach, two of them are prominently used. And these methods depend on the source of comparable valuation. 

Here are those methods: 

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#1. The public company comparables method 

The first method/approach in market value based business valuation, i.e., the public company comparables, uses metrics of valuation from publicly traded companies. And for the purpose of valuation, such publicly traded companies are earmarked that are rightly similar to the subject entity or the company to be valued. 

But there’s a catch here. 

In most circumstances, drawing a direct comparison can be a hard bargain for even the most seasoned forensic accounting expert. That’s because a large majority of publicly traded companies are not only too large but also lack similarity with the subject entity. 

Nevertheless, the benchmark of direct comparability is mostly flexible, thus ensuring that public entities with comparable business features are included in guiding the subject entity’s company valuation. 

You see, even though direct comparability is still achievable in some industries, such entities aren’t without challenges like prevailing differences between public operators and private entities. As such, the process of selecting a public company and adjusting and applying its valuation data is quite complex, requiring extensive experience and business appraisal skills. 

Further, when choosing a company to guide the valuation, the ideal choice should be such companies that have been publicly traded as subject entities in the same or similar industry. Also, if the demand and supply factors, financial buildup, and operational procedures of such companies resemble the subject, they can be the basis for comparison. 

#2. The precedent transactions method 

The precedent transactions method of the market value approach involves calculating a business’s value by deriving pricing multiples of comparable entities. And the pricing multiples used here are derived by closely observing the transactions of companies operating in the same industry. 

This method is an outcome of the perception that while in-depth financial data of comparable businesses are rarely available, their transactional value is available with ease. 

In fact, precedent transitions are something you can analyze through traditional methods of industrial classification like SIC codes. Also, there are databases of evaluation that you can analyze for proof of historical valuation accounts since such transitions can represent different perspectives. 

The most desirable guidelines from precedent transactions are from highly comparable companies operating in the same business. 

However, there is always the possibility of a lack of direct comparison. And in such cases, you can use otherwise available data after considering factors like products and markets of the comparable. 

What is the utility of precedent transactions method in the market value approach? 

Well, the precedent transitions can come in very handy in such instances where a sale or purchase is involved. Also, they can act as an exit strategy for the management of a firm. 

Nonetheless, while using this method, you should be aware of the fact that some transactions may have happened in a fairly diverse market. As a consequence, the data might not reflect the existing environment for mergers and acquisitions. 

Another challenge in this company valuation method is a lack of information in both the public domain and the databases. And that makes it difficult to find if a certain transaction is suited for use as comparable data. 

Things to consider while using either of the methods:  

For both methods in the market value approach, it is important to look for such companies that are adequately comparable to the business under evaluation.  

Here are some factors you can consider to determine if a company is comparable enough to derive the right value: 

• Whether or not the company is operating in the same market. 
• The size of the entity is similar, meaning it’s neither too big nor too small in comparison. 
• Both your company and the comparable firm offer similar products and services. 
• Whether or not both companies are in competition. 
• The physical location of both firms. 
• Whether any of the company is functioning in multiple markets. 
• Whether both businesses have identical profit margins. 

What are the advantages of the market value approach in business valuation? 

There are multiple advantages of the market approach in company valuation, which include the following: 

1. The approach considers current market conditions to assign a value to a company, making it a critical method under constantly changing market dynamics. That’s because this approach assigns the most accurate value to a business by taking into account the latest developments in the market. 
2. Instead of making subjective assumptions or forecasts about how much a firm’s worth could be, the approach utilizes realistic data readily accessible to the public. 
3. The methods used in the market value approach, no matter how complicated they may sound, offer straightforward solutions for business valuation. In fact, the simple calculations that the methods use make them attractive for businesses seeking a simple, quick, and reliable valuation. 

Are there any disadvantages of the market approach? 

No business valuation method is without drawbacks, and that holds for the market value approach as well. And here are the cons of the market approach: 

1. The question as to how much data on comparable businesses is publicly available and whether or not the data is applicable is never-ending. 
2. The process of identifying such transactions of companies that are identical to yours is very difficult. As such, you’ll always face a lack of comparable companies and relatable transactions. 
3. Both public company comparables and precedent transactions involve detailed research and complex math, making the overall approach less flexible than others.

You might also want to read: Top 10 Reasons for Business Valuation in 2023

How to analyze a comparable company using the market value approach?

A comparable company analysis is key to accurate business valuation using the market value approach. And that involves analyzing the stats of similar entities and using them to derive the value of your business. 

In a nutshell, the study of a comparable company is a five step process, starting with identifying the comparable subject and involving a calculation of similar ratios.

In case you’re wondering, here’s how you can estimate a company’s value using the following steps of comparable analysis: 

Step #1. Identifying the right comparable entity

The very first thing that you’ll need to do is compile a detailed description of the business you’re seeking to evaluate, including its scale, market, type of operations, etc. 

Thereafter, you should look for databases of identical companies operating in the same industry. Herein, the closer the match you get, the better the results of the valuation. 

These are some criteria where similarity is sought: 

• Overall turnover and profit margins. 
• The rate of growth. 
• Business size. 
• Classification of industry. 

Step #2. Gathering financial data

After you’ve pinpointed the companies that match the specifications of your business, you should gather and put together their financial information. And for this purpose, platforms like Capital IQ and Bloomberg Terminal can be your one-stop solution for all resources, especially for publicly traded companies. 

The financial data that you’ll require for business evaluation services will also depend upon factors like your company’s niche and stage in the business lifecycle. 

Step #3. Setting up the table of comparison 

Having got access to relevant financial data, you now need to put together a table, listing every piece of information that you have on the comparable entities. 

And that includes: 

• Names of the companies. 
• Prices of their shares.
• Revenues. 
• Net debt.
• Market capitalization.
• Earnings before interest, taxes, and amortization (EBITDA). 
• Earnings per share (EPS). 

Step #4. Calculating the ratios

Now that you have the list of financial information, historical data, and other estimates all on one table, you should now start calculating the different ratios that will be used in valuing your company. 

The ratios will include the following: 

• Price to book ratio, aka P/B (also called the market to book ratio). 
• Price earnings ratio (P/E)
• EV/EBITDA (a ratio comparing a business’s enterprise value to the earnings before interest, taxes, and amortization). 
• EV/Gross profit (a ratio obtained after dividing the enterprise value by the annual gross profit). 
• EV/Revenue (a ratio obtained after enterprise value by the annual revenue). 

Step #5. Using the multiples for company valuation

To determine the value of the subject company, you can take an average of the multiples of comparable businesses. You can then apply the outcomes to the metrics on the table, including gross profit, net income, revenue, EBITDA, etc. 

Also, to derive a reasonable average, you might have to exclude certain outliers and continually adjust the figures till the time they’re realistic enough for practical application. 

Know the Real Worth of Your Business with Just One Click!

Our business valuation team offers a free 30-minute no-obligation consultation service to understand your needs and issues and provide you with the best solution.

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You might also want to read: The Ultimate Business Valuation Guide for 2023

Conclusion

As you can see, the market value approach to business valuation is a highly reliable way to tell the precise value of a company in the present economic/industry circumstances. 

And contrary to how it may appear at the outset, using the approach is very simple. That’s because all you need to do is gather publicly available information and undertake a comprehensive comparison. 

If you’re looking for one such business valuation in Utah or just about anywhere in the country, you can reach out to us. 

At Arrowfish Consulting, we are a highly seasoned team of business valuators and forensic economists with 200+ years of combined experience. So whatever be your business appraisal needs, we’ve got them covered.