Business valuation using market comps – best practices
If you are valuing a private business for any reason, the market approach should be an essential part of your analysis. There are a couple of methods you can use to establish the value of a privately owned firm:
- Comparative transaction method
- Guideline public company method
To use the comparative transaction method you basically develop a set of valuation multiples by observing the recent sales of private businesses that are similar to yours. These companies should be involved in the same market sector, be about the same in size, and show similar financial and operational attributes to the firm being valued.
The challenge: data quality and transparency
The main challenge with using the comparative transaction method is gathering enough reliable data on such comparable business sales. Here are the main problems you are likely to face:
- Private business sale data reporting is not required by law, many deals go completely unreported.
- Business financials for private firms are not subject to financial reporting standards such as GAAP. This affects the reliability of your valuation multiples.
- When debt financing is hard to come by the deal flow for private business acquisitions slows down. So there are fewer recent transactions to compare against. This has certainly been the case in the recent economic environment as investors shied away from doing more risky deals.
- The reported data are not subject to review by independent financial accounting entities. This is quite unlike the reports on public companies.
In contrast, there is plenty of reliable data on business sale transactions involving publicly traded firms. These transactions are usually reported to government agencies, such as the Securities and Exchange Commission in the US. The filings are made along with the audited financials so the valuation multiples you get are pretty reliable.
However, the guideline public companies, even small ones, are usually far more marketable than their privately owned counterparts. This reduces the investor risk and makes business ownership interests more valuable.
Best practice: tap into several sources of market data
Given this, what is the best practice you can adopt when using the market-based business valuation methods?
Combining the comparative transaction and guideline public company methods may be a good choice. You can gather enough data on private business acquisitions that you consider reliable. Where such data are insufficient or missing, consider using the guideline public companies that closely resemble your business.
This works quite well for the mid-market sector because many of such private firms are managed similar to the public companies. Once you have calculated the desired valuation multiples for your comparison, do not forget to adjust them for the lack of private company marketability using an appropriate DLOM (discount for lack of marketability).
Using this combined approach should give you enough tools to do a market based value comparison for just about any private business. As a rule, the market based valuation results are reported in the Low – Median – Average – High format.