Market Approach

This method compares the company to other companies contained within the same SIC (Standard Industrial Classification) codes. Past transaction data gives us a price-to-sales multiple which is then multiplied by the current year’s revenue. Assets are added and liabilities subtracted to give an estimated value of the business.

This method can be useful to give a company a general idea of what it might be worth on the market, but there are some other considerations:

• How old are the comparable transactions? Market conditions may have changed since the time of the transactions.
• Are the transactions comparable? Have similar or comparable companies been selected? Are the markets in which they operate comparable?
• If EBITDA or EBIT of the company being valued contains distortions, then these distortions will only be accentuated when applying a multiplier.
• There may be certain “skeletons in the closet” which make the company being valued completely unsaleable, in which case any valuation is purely artificial.

In certain cases if private company information is not available or not applicable, then publicly listed company comparables may be used. Keep in mind that publically listed companies usually trade at higher multiples than smaller mid-sized private companies, as they are much more liquid, have better corporate governance, are more transparent, and usually have less risk. When valuing a private company, an appropriate discount must usually be applied to the multiple derived from public companies. Estimating the size of this discount is highly subjective and requires both experience and good judgment.