When it’s time to place a value on your company, there are three valuation approaches that are generally accepted for determining the value of a privately held business. For this discussion, let’s focus on the Market approach.
Simply put, the market approach is based on the theory of substitution. That means comparing the value of an asset, business or ownership interest in a company to the value of a similar asset, business or ownership interest. When using this method, the valuation analyst identifies “Guidelines” from which metrics can be developed for valuing the ownership – whether it’s the entire company or a smaller piece.
Sponsel CPA Group subscribes to resources containing transactional information, from which we can identify these guidelines. These resources publish summaries of the data they collect on transactions. This data can be extremely helpful in understanding general market indications. But they must be considered cautiously when applying them to the valuation of a specific business.
According to 4Q 2014 Pratt’s Stats Private Deal Update (a quarterly publication analyzing private company acquisitions by private buyers), the number of reported transactions increased by approximately 90 from 2013 to 2014. The median reported multiple of Market Value of Invested Capital (MVIC) to Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) for transactions across all industries reported for year to date 2014 was approximately 2.3 – a decrease of .77 from 2013.
Another source, the PitchBook’s 4Q 2014 U.S. Private Equity Breakdown report, stated 2,097 deals were completed by the end the third quarter. Deal volume increased compared to the third quarter 2013’s 1,364 deals completed. This is an increase of approximately 700 deals between 2013 and 2014. The median exit EBITDA multiple decreased from 10.7x in 2013 to 9.7x in 2014. According to PitchBook, the decline of the EBITDA multiple is mostly due to smaller equity commitments versus acquiring debt to close a deal.
The trend data for the number of transactions in each of the publications indicates an increase in deals. However, there is a wide disparity in the valuation multiples reported. This difference is probably due to the size and sophistication of the companies analyzed in each publication.
Pratt’s Stats is for smaller privately held businesses, while the private equity investments in PitchBook are for larger companies with potentially complex capital structures. In other words, each publication is only representative of the population of data represented.
This is an important concept to grasp when relying on the market to derive a value for a privately held business. Generalized information, while easy to obtain and understand, may not be representative of the subject asset, business or ownership interest in the business being valued. Issues such as size, growth, customers, competition, liquidity, profitability, management, location, etc., are all factors that should be taken into consideration when arriving at a valuation under the market approach.
If you ignore these differences, or assume they are somehow eliminated by using an average of the entire population of data, you could get an incorrect indication of value.
If Sponsel CPA Group can be of assistance in helping you with a valuation or litigation need, please feel free to contact Amber Hoover at (317) 613-7844 or [email protected].