Using Market Business Valuation Method
The market method of business valuation should give the most credible and defendable value of a business because it uses actual market transactions as part of the business valuation process.
However the market method of business valuation can also produce inflated or incorrect results.
We will walk you through the valuation process and tell you why this business valuation method can be so hit and miss.
Why Is The Market Business Valuation Method So Good?
There are two phrases that I often hear and it can sometimes suggest that the person doesn't really understand how to value a business:
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"The market is the market"
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The value of a business is whatever someone is prepared to pay for it"
They tend to be obvious statements and of little help - however the market business valuation method takes the statements to the extreme and uses the market to tell us what a business is worth.
The premise is that the valuation metrics of a comparable business that has recently transacted can be used to infer the value of your business. In essence you use the enterprise value:EBITDA multiple from the transaction and apply it to your EBITDA and...BOOM!!!...you have the enterprise value of your business.
Sounds great in theory but there are at least two implicit assumptions in this business valuation method (sometimes more):
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You can find a business transaction where you have access to the transaction details.
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The business that was sold was comparable enough to your business such that you can apply the same business value metrics
These assumptions are often erroneous and make this business valuation method dubious or wrong and hence this business valuation method should be used with a lot of caution.
That said the ATO in some circumstances will consider this method as the primary arbiter of business value - after
all it is the market telling business owners the value someone paid for the business. So under the right circumstances this method can be the primary method of valuation.
Lets look unpack this business valuation method in more detail.
The Market Method Business Valuation Formula
In essence the business valuation formula is based on the same used in the income business valuation method:
Value = Price * Quantity
In this case we use the implied EBITDA multiple from a comparable transaction and apply this multiple to your own EBITDA. The EBITDA used should be adjusted based on the processes we have detailed in our Business Valuation Calculation Guide.
How to Select A Comparable Business To Use With This Business Valuation Method
Ideally you want to select a business transaction where the business is exactly the same as yours!
As this is unlikely here are some of the comparable features you should be looking for:
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Operating in the same industry as yours and providing similar products and services.
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Is comparable in size (although adjustments can often be made for this difference).
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Preferably operating in the same geographic location, although this is not a hard and fast rule.
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Has a similar risk profile (similar operations, use of technology and business structure).
In some cases we would use Enterprise Value:EBITDA multiples from ASX listed entities and adjust these multiples to reflect an upper limit to apply to the market business valuation method. We have written more detail on this process of EBITDA Multiple adjustment in our recent blog posts:
In some cases, such as early stage technology start-ups can use a similar version of this business valuation method called Last Money In. This is detailed in our Business Valuation Calculation Guide, including when it should be used.
Go to Our Business Valuation Calculation Guide
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First read the guide under the heading introduction so that you have grasped the calculation of Adjusted EBITDA.
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Go to the Market Method section of the guide and calculate the implied EBITDA multiple using the comparable transaction data you have available.
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For more information on EBITDA multiples see our Valuation Affairs newsletters here.
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Fill in the relevant table in the Market Method section of the Guide to calculate the enterprise value of your business
Now return to the main Online Business Valuation Calculation Guide and and continue through the flow chart.
When To Use This Business Valuation Method
This method in essence tells us what the market value of a business is by using real transaction data to infer the business value. It is the market telling us what the market is preapred to pay.
In most cases, because of the difficulty in securing reliable data of businesses that are reasonably comparable, we see this method as a secondary business valuation method (or a cross check) rather than the primary business valuation method.
This business valuation method often provides a reality check to a business valuation and can be used in commercial disputes or divorce business valuations, selling a business, buying a business or developing a succession plan.
This business valuation method is not appropriate when you have made consistent losses and those losses cannot be offset by one-off costs or events that are unlikely to continue in the future.
Remember that it is easy to overstate the business value using this business valuation method by inflating the projected EBITDA expected in the coming years. In most cases projected EBITDA should be based on real evidence that someone else with the same information would make the same conclusion. Give it the sniff test to make sure that the business valuation is believable.
Now return to the main Online Business Valuation Calculation Guide and and continue through the flow chart.
DISCLAIMER
This valuation process and information is general in nature and is to be used at your own risk and discretion. We take no responsibility for any errors in calculation or judgement that you may make based on our information or advice.
We are not responsible for any commercial loss you may realise as a result of relying on the information or analysis that you complete.