As director of a company, it is very possible that, at some point, you will be required to conduct a business valuation. While this process may be common, it can also be highly complicated for the uninitiated.
One of the reasons for this complexity is the number of potential methods that can be utilised, each with their own advantages and disadvantages.
One of the more common methods is market approach business valuations, which prioritises looking at the current market in order to determine the business’s value. This approach is likely the most accessible way to determine the value of your business. However, while it may be simple, it is also not always the best option for every company looking for a valuation.
In this blog we will discuss the intricacies of the market approach to business valuation, what it entails, how it works, and what the pros and cons are.
What is the Market Approach Method of Valuation?
The market approach method of valuation is one of the most common approaches taken to determining the overall value of an asset, often a business. This method primarily focuses on the selling price of similar assets within the same field in order to establish a baseline of value.
Useful regardless of what asset it is you’re looking to value, the market approach is done by studying the most recent sales of companies in similar markets and using that to form an initial estimate of the value — with adjustments made depending on the differences between the sold company and the one undergoing the valuation.
For market approach business valuations, the process requires you to determine the value of all company’s assets, looking at their recent sale price.
Alongside the income, asset valuation, and earnings method, the market approach is one of the most common methods to ascertain what your company is truly worth.
How Does Market Approach Valuation Work?
Market approach business valuation works by seeking comparable businesses, generally within the same industry, and looking into what their sale price was. This price is then used as a basis to compare your company against.
The core approach is based on the premise that a similar company, of similar size, in a similar industry, may be a worthwhile comparison.
However, the market approach is not as straightforward as simply comparing prices. Instead, it requires looking at these similar businesses in order to assess a ‘multiple’. However, it’s important to remember that while two businesses can be similar, they will never be identical. So you can’t rely solely on comparing the sale price of two businesses, you must instead evaluate the basis for these prices.
Essentially, you would need to consider key factors like Earnings Before Interest, Taxes Depreciation, and Amortisation (EBITDA) or company profits after tax to arrive at a more accurate valuation. These financial metrics help account for the unique characteristics of each business.
Therefore, while highly useful, when it comes to assessing a company’s value, it is recommended that you utilise this method alongside one or two other methods.
Market Approach Valuation Pros and Cons
The market approach can be an excellent technique for a business valuation, particularly if your company has a number of comparable peers/competitors in the market to compare with. However, it has limitations, and in an ideal world would be used alongside other methods in order for a fuller picture.
Just a few of the market approach valuation pros and cons include:
Pros:
- Ease of Calculation: Unlike some of the other methods, market approach business valuations are fairly simple to understand. There aren’t any potentially confusing formulas to use, as all you need to do is understand your market. This makes it much more accessible to a wider variety of company owners to jump into.
- Suits Investors: If you’re on the lookout to attract investors, a surefire way to draw them in is to show them where the money can be made. If you can prove that a company similar to you has attractive value, then potential investors might be more open to discussions.
- Tangible Data Source: Market approach business valuations are built around real-world market data. This means that there are much less estimations as the valuation is based on something more tangible. As a result, the final value provided is a more realistic reflection of the value of the company in the market conditions of the day.
- Respected Method: As one of the most commonly used methods, market approach business valuations are widely accepted by stakeholders.
Cons:
- Comparable Assets Hard to Find: For some firms, genuinely comparable companies can be difficult to locate. This is especially true if the business is operating in a niche industry.
- Factors to Consider: No two businesses are ever exactly the same. As a result, common differences between two seemingly similar businesses can include differences in size, key assets, and location; these various factors can make it difficult to get a total picture.
- Only for Established Firms: A market approach business valuation is only really useful for established companies. Many newer firms and startups will have less comparable companies in their market to treat as a baseline.
- No Inwards Analysis: This approach focuses primarily on factors outside of the business. As a result, things that may often impact the value such as high-value assets and company location, are ignored.
- Markets Fluctuate: What a company sells for one year, may not be what it would sell for a year later, or a year before. This can affect the accuracy of the valuation, particularly in times of economic fluctuation.
- Data Availability: It’s important to consider data availability when using the market approach for business valuation. Typically, data is readily accessible for Publicly Traded Companies (PLCs), but may be limited for others. Some analysts will have access to this date, but acquiring it can often prove costly
Business Valuation Support to Rely On
As this blog shows, the market approach method can be a useful tool to determine the value of a company. The simplicity of the methodology is highly attractive to many. However, it is not useful for every business due to some complications that can arise.
If you are considering a market approach business valuation, it is vitally important that, while thinking of the benefits it can bring, also recognising its limitations — particularly for niche or newly established businesses.
As an experienced team of forensic accountants, we understand the difficulties that come with running a business, as well as the complex nature of business valuation at the best of times. The appeal of a market approach business valuation is there for all to see. However, we advise caution.
While yes, the approach is simple and can be highly useful and informative, it can also be limiting and ignores some often vital data. As a result, it is recommended to consider a more all-encompassing business valuation.
Our team has years of experience working with company directors to help them work out the value of their company. We understand the positives and negatives of each method, and which approach works best for which type of business. This makes us perfectly placed to offer our assistance for those who need it.
Whether you are considering a business valuation to help you plan for the future, or you’re dealing with an ongoing dispute with a shareholder or your partner, we are here to help. Contact us today for more information.
