Business Valuation - Market Approach

SME Transaction Comparables - Market Approach

The first Market Approach to business valuation is by using SME transaction comparable data. This obtainable data is through voluntary submission by business brokers.  Using past transaction data of SME business sales, we can have a strong feel for the value of a current comparable business. The market data used in this market approach shows what the market is willing to pay for a similar business. This approach is not theoretical, rather it is direct. The market is made up of thousands of buyer and sellers. To understand the market, we need to know what buyers’ objectives are. The two factors affecting their decision are what are the earnings, and how much they are willing to pay for that earnings.

To use this Market Approach, you will need access to a subscription based database which tracks SME transaction data that are submitted by participating brokers nationwide.

Key notes:

  • Important to identify a close comparable to the business you are valuing.
  • Adjust the multiple to account for differences in the comparables. i.e. better profit/gross margin, better return on capital, etc.
  • Use as recent data as possible. Not over 5 years, maximum 7.
  • Understand the data provided. Account for market conditions i.e. 2008 great recession.

Steps to Determine SME Transaction Comparables:

  1. Get transaction data for comparable businesses.
  2. Review the data, study the dates and adjust for market conditions and outliers.
  3. Compile values
  4. Adjust values to match business size.
  5. Average the enterprise values (sale price) of given data.
  6. The average EV gives you an estimate of the enterprise value of your business.

Public Company Comparables - Market Approach

The second method in the Market Approach for business valuation is the Public Company Comparable method. Due to SEC or Provincial Securities Commissions in Canada requiring audited financial statements and disclosure of public companies, data on such companies are freely available to anyone. This allows anyone to use these data to compare another similar company. Generally, the Public Company Comparable method may be used to evaluate a business valued over $50 million using 3 or more similar public companies.

Key notes:

  • Not to be used to compare if the difference between the public company and business being evaluated is large and requires a 50% or more adjustment.
  • Not to be used if private company has unusual issues. i.e. major lawsuits, fraud, high customer concentration.
  • Note any unusual share price performance of the public company due to acquisitions (takeover announcement) or financial engineering (share buyback announcements).

Steps to Public Company Comparable

  1. Find the SIC Code and/or ask the business owner who they compete with that are public(listed) companies.
  2. Identify 3 or more similar companies.
  3. Extract the current financials for the public company and the current stock price and performance. PE ratio. Discard low liquidity companies (low traded volume or penny stocks/pink sheets).
  4. Discard companies with unusual activity. i.e. acquisition target announcements (inflated stock price), share buyback announcements, etc.
  5. Calculate the private company financial ratios and compare with the public company ratios. Make adjustments accordingly.
  6. Make adjustments to private company for lack of marketability, better key financial ratios, etc.
  7. Use the average multiple (or PE ratio) to calculate the value of the private enterprise adjusted for lack of marketability.


Merger & Acquisition Comparables - Market Approach

The last but equally important Market Approach method is the M&A Comparable method. The M&A Comparable method and the Public Company Comparison method are similar within the Market Approach but with subtle differences. Instead of taking data from the stock market, it is taken from M&A deals where the information is better available than for SME transactions.

Key notes:

  • In M&A deals, whole (or majority stake) companies are transacted at once and provide a lot of information. However, for stock market, the valuation is very current.
  • M&A deals may already reflect the lack of marketability adjustment into their deals. Get a deeper understanding of the transaction if data is available.

Steps to Merger & Acquisition Comparables

  1. Search for a few sample M&A transactions for similar companies.
  2. Compile data, analyze, compare, and adjust to subject (company you are valuing) for size, financial ratios, lack of marketability (if any).
  3. Use the average multiples of comparables to determine subject company value.