Market Approach to Valuation

The chapter outlines the principle of the market approach. The subject company being valued is compared either to a similar company that has recently been sold (precedent transaction analysis) or to a group of companies that belong to the same industry and have analogous business models, described as the peer group (comparable company analysis). Once the comparison is established, the multiples of the comparable companies are applied to the aggregates of the subject company to obtain a value estimate, using the following formula: $$\begin{aligned} {\text{Value}}\,{\text{of}}\,{\text{the}}\,{\text{Subject}}\,{\text{Company}} & = {\text{Normalized}}\,{\text{Aggregate}}\,{\text{of}}\,{\text{the}}\,{\text{Subject}}\,{\text{Company}} \\ & \times {\text{Adjusted}}\,{\text{Multiple}}\,{\text{of}}\,{\text{the}}\,{\text{Peer}}\,{\text{Group}} \\ \end{aligned}$$ Value of the Subject Company = Normalized Aggregate of the Subject Company × Adjusted Multiple of the Peer Group . The formula applies to historical or projected data. A discount is often necessary when the subject company is a small business, and the market multiples used come from a group of larger listed companies. This discount primarily considers the lack of marketability, small size effect, and the key person risk factor. The difficulties specific to this method lie in selecting the sample group of comparable companies (peer group) and the relevant and available market multiples. Several short case studies and illustrations are included. Key takeaways on the market approach and its limitations conclude the chapter.