Value Blog

Valuable Answers to Your Business Valuation Questions

20 Jul

What does the market approach capture?

Posted in General valuation topics on 20.07.09

The conceptual background behind the market approach is to use the behavior of buyers and sellers to arrive at a multiple which reflects the market.  Market methods can be divided into two basic groups: guideline public companies and private company transactions.

There are some major distinctions between the underlying data used for each method.  The public guideline company method uses information from publicly traded companies that are most similar to the company being valued.  The appraiser’s analysis of comparability may include factors such as type of business, size, geographic operations, growth prospects, past historical operating performance and any other factors which may be appropriate.  The appraiser identifies the most comparable companies and then derives valuation multiples based on the trading prices of the guideline companies’ stock as of the valuation date.  This data is based on marketable, minority interests in the guideline companies.

Private company transaction methodology is generally based on the theory that a sufficient number of private transactions will emulate the market for that type of company.  There are a number of databases which track private transactions of companies.  The information is collected from business brokers and intermediaries involved in the transactions, who report the information to the database services.  Each database contains different amounts of information regarding the companies.  The information about these companies represents a non-marketable, control interest in the transaction companies.

So what is the difference?  The public company transactions are evidence of the market value based on a large number of transactions which have been completed between buyers and sellers.  That is the reason that a large number of public companies is not required in order to use the methodology to arrive at valuation multiples.  Each company alone is evidence of the market.

Private company transactions may or may not take place at market value. Buyers and sellers have their own motivations for entering into transactions.   There is only one transaction for each company, unlike with public companies where you could have anywhere from under one million to over 250 million trades in a single day.  The concept behind private company transaction methodology is that with a sufficient number of transactions, the average or mid-point will represent what the market looks like.  That is why more transactions are necessary under the private company transaction methodology.  A few transactions may not be sufficient to represent the market.

What is important to understand is that each valuation is different. Applying any methodology is based on the facts and circumstances particular to the company being valued and the valuation date.

©2009 Florida Business Valuation Group


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24 Apr

Business Appraisals for the IRS: Qualified Appraisers

Posted in Valuation dictionary on 24.04.09

The IRS first required that taxpayers use qualified appraisers under the Pension Protection Act of 2006 in relation to claiming charitable deductions. The definition of qualified appraiser has been incorporated into penalty rules as well.

A qualified appraiser is defined as an individual who has “verifiable education and experience in valuing the relevant type of property for which the appraisal is performed”[1]. In order to have the appropriate level of education and experience for a business appraisal, an appraiser must have completed business appraisal coursework with passing grades offered by a professional organization or college AND have two or more years experience in business appraisal. The Proposed IRS Regulations clarify that an appraiser who has received a recognized appraisal designation from a professional appraisal organization is deemed to have met the education and experience requirements. (See post “How do I find an appraiser?” April 20, 2009 for a list of the appraisal organizations.)

The Proposed IRS Regulations further identify people who are NOT qualified appraisers. In particular, an appraiser whose fee is based on the value of the business is not a qualified appraiser. The donor or the donee of the property being valued cannot prepare the appraisal either. Related parties to the donor or donee also fall into this group. Any individual who has been barred from practicing before the IRS with the three years before the appraisal date is not a qualified appraiser.

This is an overview of the rules for qualified appraisers. If you are valuing a business for IRS compliance purposes, you will want to make sure that the business appraiser you select is a qualified appraiser.

© 2009 Florida Business Valuation Group

[1] Internal Revenue Ruling 2008-40


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16 Apr

Valuation Terms

Posted in General valuation topics, Valuation dictionary on 16.04.09

There are terms that are frequently used in valuation that have specific meanings.  A group of the appraisal organizations got together and created a glossary defining various terms, the International Glossary of Business Valuation Terms.  Definitions below are taken from the Glossary.

An appraisal is the same as a valuation, which is defined as “the act or process of determining the value of a business, business ownership interest, security or intangible asset.”

The three approaches to valuation are the asset approach, the income approach and the market approach.  Within each approach are various methodologies used in the process of business valuation.

The asset approach is “a general way of determining a value indication of a business, business ownership interest or security using one or more methods based on the value of the assets net of liabilities.”

The income approach is “a general way of determining a value indication of a business, business ownership interest, security or intangible asset using one or more methods that covert anticipated economic benefits into a present single amount.”

The market approach is “a general way of determining a value indication of a business, business ownership interest, security or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities or intangible assets that have been sold.”

Discounted cash flow method is “a method within the income approach whereby the present value of expected economic benefits is calculated using a discount rate.”

Discount rate is “a rate of return used to covert a future monetary sum into a present value.” The discount rate converts future net income, earnings or cash flow to a present value.  The rate is used in a formula which takes into consideration the point in time in the future when the benefit is expected to be received.

Capitalization rate or cap rate is “any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.”  In simple terms is a rate that is divided in an estimate of net income, earnings or cash flow for a single period to arrive at a value of a business or business interest under the income approach.  The higher the rate, the lower the value.

A multiple is “the inverse of a capitalization rate.”

These definitions are a start to understanding the terminology used by appraisers.  In future postings I will discuss the application of different approaches and methodology.

© 2009 Florida Business Valuation Group


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