When valuing a home, a real estate agent usually looks at comparable houses sold near-by. The same process can be adopted in business valuation. The business valuer looks at comparable businesses that have been sold or shares in companies that are traded. This is a market approach. Unlike an intrinsic valuation, the market approach provides a guide to pricing. What are buyers prepared to pay?
Houses can be compared by number of rooms, plot size and location. It is not so easy to compare businesses. Businesses often have unique characteristics, such as products and services, intellectual property, employees, agreements, assets, technology, customers and suppliers.
In some instances, publicly traded companies may have similarities to the subject business. In this situation the business valuer maybe able to use this information to provide a guide to pricing. Publicly listed companies are liquid, and prices only reflect systematic market risk. The business valuer must adjust for the lack of liquidity in the ownership of privately held company and that investors are exposed to unsystematic, business risk.
When carrying out comparable analysis, business valuers often refer to value as amultiple of earnings. For example, the business valuer may successfully obtain details of a dozen transactions business all very similar to the subject business. All the transactions took place at three-times earnings before interest and tax (EBIT). Consequently, the business valuer may infer that the market data supports a price of three-time EBIT.
Unlike houses, however, private businesses are not frequently sold and when they are sold, the transaction information is often not publicly available.
A potential source of private business transaction data are the annual financial statements issued by publicly listed companies. Certain publicly listed companies maybe have acquired privately held businesses in the same or a similar industry. The transaction information can sometimes be found in the notes to the financial statements. Not all companies disclose financial transactions in the same details or in the same way. Consequently, obtaining transaction information can be time consuming and limited.