By Jason Thompson, Partner and Director of Valuation and Litigation Services
When it’s time to put a price tag 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 veteran valuation analysts at Sponsel CPA Group identifies “Guidelines” from which metrics can be developed for valuing of the ownership – whether it’s the entire company or just a slice of the pie.
Sponsel CPA Group subscribes to myriad resources containing transactional information, from which we can identify these guidelines. These resources, which have begun publishing summaries of the data they collect on transactions, can be extremely helpful in understanding general market indications. But they must be considered cautiously when trying to apply them to the valuation of a specific business.
According to Pratt’s Stats Private Deal Update, a quarterly publication analyzing private company acquisitions by private buyers, the number of reported transactions decreased by almost 200 from 2010 to 2011. The median reported Market Value of Invested Capital (MVIC) to Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) multiple for transactions across all industries reported for 2011 was approximately 2.5 – virtually the same as the 2010 median multiple.
Another source, the PitchBook & Grant Thornton Private Equity Exits Report, 2012 Annual Edition, reports that exits by private equity firms in 2011 were down slightly compared to 2010 (420 total versus 434). This source, however, indicates a much larger median exit EBITDA multiple: 8.6 times for 2011, up from 8 times in 2010.
As you can see, while the trend data for number of transactions is similar in each of the publications, 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 Grant Thornton 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., all factor in significantly 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 two distinctly different indications of value – both of which may be incorrect!
That’s why you need a valuation analyst who can utilize these resources for a market-based valuation, while grasping their inherent limitations when applying them to a specific business.
If Sponsel CPA Group can be of assistance in helping you with a valuation or litigation need, please feel free to contact Jason Thompson at (317) 608-6694 or [email protected].