ValuAdder Business Valuation Blog

Business valuation tips, updates and advice. Pick up a few suggestions on how to value a business. Feel free to browse the contents or share your thoughts by leaving a comment.

Tired of blowing wads of money on overpriced database subscriptions? In business valuation, like in many things, the devil is in the details. Without a thorough work up of the cost of capital you can’t get usable discount and capitalization rates.

Slick data brokers would have you believe that they somehow create the market data you need. No surprises there, they want you to buy into the expensive database subscriptions as the only way to get at the data. Then you get stuck with the bill.

Good News: business valuation data is public and free

How about the secret the data brokers don’t want you to know? Check this out:

  • All the market data you need for your business valuation comes from the public capital markets.
  • And best of all, this data is absolutely free.

Let’s take a look at the renowned Build-Up cost of capital model.  That’s the model professional appraisers use it to calculate their discount and capitalization rates, as well as the valuation multiples.

What you see is a number of components that are added up, starting with the risk-free rate of return.

Where do the gurus get the risk-free rate? That’s right, from the US Treasury yields, published for free by the, you guessed it, US Treasury.

There is a reason why you can use these yields as the measure of risk free rate of return. Because market participants believe Uncle Sam will always pay off its debt obligations.

Why the US Treasurys are a risk-free investment

Now you know that the USA controls the reserve currency (US dollar). So the Treasury can always cover its debt by printing more paper money. Do you invest by buying US Treasurys? Then you are guaranteed to be paid off at maturity and receive your interest payments in full and on time.

What about the equity risk premium or ERP in the Build-Up model? Available from the public capital markets for free again! The ERP is easily calculated from the S&P 500 index total returns using standard models such as the discounted cash flow. You don’t need to waste a penny on this one!

Industry risk premiums

The same goes for the industry risk premium. You look at a sample of public companies in your industry sector using either SIC or NAICS codes published by the US government. Stock prices of these companies are public knowledge. So figuring out the returns in your industry sector is a breeze. Compare this to the return observed in the market as a whole and you can factor out the industry risk premium.

Size risk premium – big is beautiful

If you followed the discussion above, you have probably guessed that the company size premium is similar to the industry risk premium. Except in this case you check out a bunch of companies within a market capitalization range that matches your subject business. Again, compare this to the returns of the equities market as a whole to figure out the size premium.

And what about the country risk?

If you are valuing businesses in a specific country or region, there is a degree of risk your subject business may be exposed to just because of the economic conditions over there. Governments sell their debt obligations on the public capital markets. So you would do well to compare the yield spreads of these government bonds to the US Treasurys. The difference indicates the additional risk of running a business in that country or region.

Valuation multiples that don’t burn a hole in your pocket

But what about the ubiquitous valuation multiples? Same story, in almost all industry sectors there are plenty of public companies whose stock prices and enterprise values are well known. If you put together some comparables from the public companies, be sure to adjust them for lack of marketability using the so-called DLOM before applying them to private company valuation.

 

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