Value Blog

One of the approaches to valuing a business is the market approach.  This approach looks to either private transactions or publicly traded stock to develop an indicator of value, usually in the form of a multiple.   Is a single transaction representative of the value in the market?

With public companies, the marketplace allows for buyers and sellers to negotiate each transaction by using bidding system.  A buyer will indicate what he wants to pay for a stock and a seller will indicate what he wants to sell the stock for.  When buyers and sellers are matched, there is a sale.  The public stock exchanges provide an efficient system for trades.

When a public guideline company method is used to value a business, comparable companies are identified and the information from the market is used to develop a market value.  Because the data captures the prices paid in the market, it is considered to be a good proxy of fair market value.  Since there are many transactions for each company, it is not necessary that an appraiser use a large number of comparable publicly traded companies in applying this methodology.  (The IRS heavily favors using publicly traded companies as a basis for value in developing opinions of value.)

When comparable publicly traded companies are not available, we look to private markets.  Private markets are no where near as efficient as publicly traded markets.  Often, limited information is available about the sale and the company operations.  Private companies are not require to report information and most information available is from database services that collect the information from brokers and intermediaries.

Since private markets are not efficient, the sales prices usually reflect an investment value rather than fair market value.

With all these challenges, how do we use these private transactions to develop indicators of fair market value?  Using private transactions is based on the concept that when transactions for similar companies are looked at together, these values represent the market as a whole.  The values for companies sold at distressed prices offset the values for companies sold at premiums, resulting in a market value.

Since the private transaction methodology relies upon a group of transactions to extrapolate multiples representative of the entire market, it is necessary to have a sufficient number of transactions to achieve this.  The problem is there is no absolute number.  We know that you need more than five transactions to get a statistically valid multiple.  Most agree that you need more than ten transactions.  The obvious answer is the more the better. With more transactions, an appraiser is better able to analyze the data into groups and arrive at a multiple based on factors that are similar to the company being valued.

While a single transaction price may be representative of fair market value, it is not sufficient to prove fair market value.  Remember price does not necessary equal value.  Price is the negotiated amount at which a transaction takes place and can be influenced by non-market factors.

For more information on the market approach, click here.

©2009 Florida Business Valuation Group