The market-based approach to valuation compares one or more aspects of the subject company to the same aspect of other companies with an established market value, to determine the value of a company.
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The variables in the market-based approach include which aspects of the companies should be compared, and which companies to select as comparables. In selecting the best comparable company it is ideal to select several public companies in the same or similar industries that are publicly traded and similar in size. Pratt’s Stats, Mergerstat, and BizComps are examples of commercial databases with statistics on companies both public and private.
The most commonly compared aspect of companies is some form of earnings, however, in some instances total revenue or book value may be more fitting. Any number of other financial criteria may be more or less useful to compare. Be sure to compare apples to apples with earning. Because taxable income can vary widely depending on financial and accounting considerations, one commonly used earnings calculation is net income before taxes, depreciation and amortization plus the value of the owner’s salary and fringe benefits, sometimes referred to as a seller’s discretionary earnings.
After selecting which aspects are to be compared, the market-based approach provides the value of the subject company by relating the value of the comparable companies on the basis of the particular aspects compared. For example, if comparable companies have recently sold for 5x EBIT, the subject company’s value should be about 5x its EBIT, and if comparable companies have recently sold for 2x book value, the subject company’s value should be about 2x its book value.
John T. Carter is a Partner with Witzke Berry Carter & Wander, PLLC in Bloomfield Hills, MI. Mr. Carter leads the firm’s Business Law and Commercial Transactions group and he has over 18 years of experience working with Michigan based organizations that service the health care, technology and professional services sectors. Follow John T. Carter on Twitter @johntcarter.