Valuing a business? Then doing a market comparison against similar business sales should ring the bell. Indeed, the market approach to business valuation is perhaps the easiest to grasp for business people and professional advisors alike.
Do your market comps hold water?
But, as often in life, the devil is in the details. In fact, the International Valuation Standards (IVS) weigh in on this by specifying when the market approach to business valuation should be appropriate:
- The subject company ownership interests have recently been sold in an arms-length transaction.
- Ownership interests in the company itself or companies closely resembling it are actively and publicly traded.
- Alternatively, there are recent and frequent, readily observable sales of similar companies.
All this makes the comparisons transparent, 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: with all this data reliability from the public capital markets, can you apply the public company comparables to value a privately owned business? There are some differences between the public and private companies that set them apart, right?
Public company ownership interests are more marketable – DLOM to the rescue
For the purposes of business valuation, the biggest difference is relative lack of marketability in private company’s ownership interests. While shares of public firms sell readily on the open market, selling a private company is a major project. This lack of liquidity works to reduce the value of private firms, other things being equal.
Business appraisers have a tool for just this sort of challenge: the discount for lack of marketability or DLOM for short. The idea is that you can adjust the business value figure you get from comparisons to publicly traded companies by using the DLOM.
This is good news indeed: you can gather the highly reliable and plentiful public company comparable selling prices, adjust your valuation multiples by DLOM and have a solid basis 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.
The premium for a controlling share of a public company is necessary 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?
Since the vast majority of private business valuations are done on a controlling ownership basis, you would need to make the control premium adjustments to any valuation multiples you get from the per-share prices of comparable public companies.