Valuing a business? Then doing a market comparison against similar business sales should ring the bell. Indeed, both seasoned valuation pros and business people find the market approach to business valuation easy to grasp.
Do your market comps hold water?
But, as often in life, the devil is in the details. In fact, the International Valuation Standards (IVS) caution against making misleading comparisons of value. So when do comparisons work?
- The subject company ownership interests have recently sold in an arms-length transaction.
- Ownership interests in the company itself or companies closely resembling it are actively and publicly traded.
- Alternatively, you can find recent, frequent and readily observable sales of similar companies.
All this makes the comparisons clear, relevant, and reliable. But wait, there is more from the IVS standard founding fathers: the comparison must be relevant to the business being valued.
Making apples to apples comparisons with guideline company data
This brings up the question: how can you apply the public company comps to value a privately owned business? Wouldn’t the differences between public and private companies make it hard to do?
Public company ownership interests are more marketable – DLOM to the rescue
One big difference: selling a private company is much harder than trading public stock. While shares of public firms sell readily on the open market, selling a private company is a major project. This lack of liquidity reduces the value of private firms.
Business appraisers have a tool for just this sort of challenge. They call it the discount for lack of marketability or DLOM for short. And it gives you a way to figure out your private business value by adjusting comparisons to publicly traded companies.
So how do you do it? First, you can gather the highly reliable and plentiful public company comparable selling prices. Next, you adjust your valuation multiples by DLOM to estimate the value of a private company.
Be sure to collect your transaction data from companies that match your target private business both in size and operational terms. There are plenty of small publicly traded companies that resemble professionally run private businesses, especially in the upper small to mid-market capitalization ranges.
Control premium – the price of calling the shots
All this really works well if you have access to transactions involving public company acquisitions. Such deals are made on a controlling ownership basis, usually following a tender offer by another company or investment group.
If you compare against the daily per-share prices, you will quickly notice that a controlling ownership acquisition offer comes with a hefty premium.
Why do investors pay a premium for a controlling share of a public company? Because they must offer it in order to induce the many individual investors to sell their shares instead of hanging on to them. The acquiror usually has to put up the control premium on top of the current market per-share price. Otherwise, why should the investors part with their shares they can sell in a jiffy if they so chose?
Now the vast majority of private business valuations are done on a controlling ownership basis. So you would need to make the control premium adjustments to any valuation multiples you get from the per-share prices of comparable public companies.