Whether you are buying or selling a business, doing estate planning or going through a divorce, you may need to know what your business is worth.
While there are different approaches to valuing a business, the market-based approach looks primarily to either the publicly traded marketplace or transactions in privately held stock to come up with pricing mechanisms to value a company, says Edward Blaugrund, CPA/ABV/CFF, CFE, an associate director in the business valuation and litigation consulting department at SS&G Financial Services, Inc.
“For the publicly traded guideline company method, you are looking at pricing mechanisms, such as price-to-earning or price-to-revenue value multiples, of companies in the public marketplace that are comparable to the company you are valuing,” says Blaugrund. “For private transactions, it’s a similar approach, but you are looking at transactions in privately held stock as opposed to publicly traded stock.”
Smart Business spoke with Blaugrund about how to value your business using the market-based approach and how the economic downturn has impacted valuations using this approach.
How do you identify companies to use under the market-based approach?
Comparability is of primary importance. You attempt to find companies that operate in the same or similar industry and have similar economic drivers as the subject company being valued. You also try to find companies that offer the same or similar products or services. Then, you start looking at metrics, such as revenue and asset size, the number of sites, geographical location, date of transaction and things of that nature.
There are many comparability factors to consider under this approach. For instance, if we are appraising a chair manufacturer, would we simply look to just any company within the general manufacturing industry to find pricing multiples? The potentially comparable companies found may be manufacturers with similar revenues and other financial characteristics; however, they might be in a different segment of the manufacturing industry or located in different cities or states and affected differently by changes in the national, regional or local economic environment. Once again, comparability is the primary objective because the value multiples derived from these potentially comparable companies will help produce a more meaningful initial value conclusion.
Keep in mind that there will be a certain amount of subjectivity when using this approach because the appraiser is using his or her discretion, experience and judgment when attempting to find comparable companies, both publicly and privately held. This may prove to be a very daunting task because in certain instances it can be very difficult to find a company that is truly comparable to the subject company.
Can business owners assess value on their own, or do they need outside help?
It really depends on the facts and circumstances of the situation. Certainly there are business owners who may have bought and sold businesses in a particular industry over the years and have their thumb on the pulse of an industry’s value drivers. However, if this is not the case, then it may make sense for the owner to hire a business appraiser.
Also, if the appraisal is to be done, for instance, for litigation or estate planning purposes, it may be recommended or required that an experienced business appraiser be engaged to make sure that certain valuation and professional standards and requirements are met in the appraisal process and report.
How has the market-based approach been affected by the downturn in the economy?
The downturn in the economy has had an effect on the multiples that we are seeing in the marketplace to varying degrees. Whether a public or a privately held company, financial performance and investor expectations may have had an effect on the value multiples being reported. Given the downturn, it is likely that the multiples are down from previous years. Further, when you look to transactions in privately held stock, the number of transactions may be down from previous years due to the change in the economy and this may, in turn, reduce the number of transactions reported in the databases that appraisers draw from when attempting to derive value metrics to utilize in a market-based valuation of a company.
Does the economy make this a bad time to do a valuation?
Once again, it depends on the facts and circumstances of the case. For instance, if you’re looking to do estate planning, this may be a good time if your business is in an industry that has been negatively impacted by the economic downturn. Using a market-based approach would generally result in a lower value if the multiples are down.
How long does it take and how much does it cost to perform a business appraisal?
Assuming all the books and records are in good order, and depending on the purposes for the valuation, it generally takes between four to six weeks to complete the process. However, based on the scope of the project and the type of report to be issued, the timing may be less. There are other factors that may impact the timing and cost of the appraisal, such as cooperation of company management and timely document production. In addition, the size of the company may impact the scope of the appraisal, as larger companies may have more complex issues to address.
