The Market Approach is one of the three approaches (along with the Income Approach and Asset Approach) used to estimate enterprise and equity value, which is one of the steps in performing a 409A valuation. The market approach employs analysis using comparables, or “comps”, in determining the value of the entity. Both public and private companies, if publicly available information exists, are considered in the market approach. Two information points commonly available – company valuation and transaction value – are used for their respective methodologies. There are a number of different methods within the Market Approach that may be used by the valuation specialist.
The three main methods utilized are:
Guideline Public Company Method
The Guideline Public Company Method is founded on the concept that companies within similar industries or similar positions within their industries will have similar valuations or characteristics upon which a valuation can be based – whether that company is public or private. It is vital to understand the subject company’s market, product lines, plans, growth in order to identify comparable public companies. One difficulty in creating a set of guideline public companies is that larger companies often have multiple lines of business. When trying to value a smaller business, it may only compete against one of these lines and be difficult to compare metrics due to this.
Guideline Transactions Method
The Guideline Transactions Method is founded on the concept that detailed private company financial data is unlikely to be available but transaction value does become available, and, on such occasion, that valuation can be used as a tool to provide a valuation for other similar companies. Using this method can be useful where a sale or purchase is being considered or is under consideration as an exit strategy for company management. Additionally, if ownership interests of the company under review compare favorably to companies that have been involved in transactions it may be a benefit when trying to value the company. Typically, this is a controlling and marketable interest, but it could be the opposite being value as well – non-controlling and non-marketable. A main challenge in determining whether a transaction can be considered within a data set of comparables is the lack of information often present in research database or in the public spectrum.
For both of the above methods, ensuring the companies used for comparative purposes, both from a standalone value and transaction value, are similar to the company being valued, or that discounts and premiums are applied for dissimilar characteristics, is critical to the success of the market approach. The sales transactions are typically for a controlling interest, so the valuation specialist will need to discount if the company under review is not in a controlling position. The same consideration for a discount exists when looking at a guideline public company which is typically a very marketable and liquid asset compared to private company stock.
A valuation specialist also may use the backsolve method to solve for the implied equity value that is consistent with a recent transaction in the company’s own securities. The basis for application of this method is transactions in equity securities of the enterprise with unrelated investors or among unrelated investors themselves. In using this method, the valuation specialist should disclose in the valuation report the rationale for selecting the transactions deemed relevant (and for excluding other transactions, if any) and what adjustments were used in estimating fair value. In selecting the relevant transactions, the valuation specialist should consider whether those transactions involve any stated or unstated rights or privileges, any effects of which would ordinarily be factored out of any fair value estimate.
Each of the methods within the Market Approach has advantages and disadvantages. The Market Approach, taken as a whole, has the following advantages and disadvantages:
- Straightforward, simple calculations
- Uses real, public data
- Does not rely on subjective forecasts
- Difficulty in identifying comparable companies or transactions
- Lack of sufficient number of comparable companies or transactions
- Not flexible
- Raises the questions – How much data is there? How good is the data?
The Market Approach, whether ultimately relied upon or not, is important for a valuation specialist to consider in a 409A valuation. Gathering data about comparable companies and transactions will teach the valuation specialist a lot about the company under review and the competitors it faces.
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