How Is A Business Valued? (Pt. 2)

Part Two of a Three-Part Series: The Market Approach

In Part One, we looked at the asset approach: what a business owns and what it owes.

The market approach asks a different question: What have buyers paid for similar businesses?

The concept is straightforward. Finding meaningful comparisons takes judgment.

How Comparable Is Comparable?

Two businesses in the same industry can have very different values. One may have established management and a diversified customer base. Another may depend entirely on its owner and a handful of customers.

I look beyond the industry classification. Size, profitability, growth, and risk all affect what a buyer would pay.

Look Behind the Multiple

The market approach relates sale prices to measures such as revenue or earnings. But applying a multiple without understanding the underlying data can produce a misleading result.

What was included in the price? Real estate? Assumed debt? Payments contingent on future performance? How were earnings calculated, and did you adjust for owner compensation or unusual expenses?

The arithmetic is easy. Establishing that the comparison makes sense is the work.

How I Use It

When reliable comparable data is available, the market approach can provide a sound basis for a valuation.

Even when I do not formally apply it in reaching my conclusion, I may use market evidence to bracket values derived by other methods. It provides a useful check on whether those results fall within a reasonable range.

If they do not, I want to understand why.

A list of transactions and an average multiple do not establish value. The analysis has to explain why those transactions tell us something useful about this particular business.

NEXT: THE INCOME APPROACH

Part Three will examine how a business’s expected future earnings or cash flow can provide an indication of value.

Need a business valued?

Forensics CPA Tax, PLLC prepares business valuations for owners, attorneys and courts, including valuations used in partnership disputes and divorce matters. Angel Alicea, MBA, CPA, is a court-appointed financial expert serving the New York metro area. Learn about our business valuation services or see how we back up attorneys through litigation support.

Call 914-727-6075 or contact us to discuss your matter.