If you are looking to figure out what a private business is worth, a natural tendency is to check the market for guidance. Think about it – whenever you need a product or service, a key question is how much to shell out. The question of a reasonable price for an asset is usually seen in the context of the ‘going rate’ – what the market evidence suggests something is worth.
So it is with businesses. If you can dig up some selling price numbers on similar companies, you can get an idea of what a similar business is likely to sell for. In the final analysis, the market is the arbiter of value.
Comparing prices of similar companies that sold recently is an intuitive and powerful way to estimate your business value. But the devil is in the details and the pitfalls abound, namely:
- Do you have current evidence of selling prices to compare against?
- Are the numbers reliable to run your comparison?
- Are there enough business sales to help you with a reasonable comparison?
Considering a private data base? Caveat emptor!
If you turn to a source of business sale data that contains irrelevant, outdated, or incomplete records, you run the risk of doing an ‘apples to oranges’ comparison. Whatever your reason for business valuation, relying on faulty market evidence is not helpful.
Yet many private databases tout numbers that seem to defy logic. Here is a simple illustration:
Let’s consider a typical database of private business sales with 10,000 sale records collected over 20 years. Let’s further assume that the business sales are evenly spread across 700 unique industries, identified by the NAICS or SIC codes. This gives you about 0.71 business sale comps per year for each industry on average.
So to get a reasonable number of business sales to compare against, say 10, you would need to look back about 14 years! To put things in perspective: in order to estimate your business selling price in 2019, you would be tapping business market values from 2005. Needless to say, the market that long ago was very different. Business selling prices hit bottom in the 2008 – 2009 time frame that few people could predict.
The curse of bad business sales data: garbage in, garbage out
Such lack of current, relevant data is a typical weakness of private data sources. Why? It is very hard to collect transactions on private companies.
Unlike their public counterparts, private businesses are under no obligation to file their transactions with anyone. Nor do they comply with established financial reporting standards such as GAAP. The fact is, most private business sales go unreported.
Guideline public company comparables to the rescue
If you are concerned about the quality of private business databases, consider using the public company selling prices as a guideline. Such information is readily available, usually from the government sources, such as the US Securities and Exchange Commission (SEC). Filing consistent, transparent reports on public companies is required by law, so you can be sure you are getting reliable data.
Comparison to private businesses would call for a discount for lack of marketability or DLOM as the business appraisers call it. The reason is that public company ownership interests are easily marketable and, therefore, worth more than those of private businesses.