The idea behind the market approach is that the value of a business can be determined by reference to sales of reasonably comparable guideline companies (also referred to here as “comparables” or “comps”) that have taken place in either the public or the private marketplace. The value may be known either because the companies are publicly traded or because they were recently sold and the terms of the transaction were disclosed. Based on the economic principle of substitution, a rational financial buyer will not pay more for a company than the current price for a comparable company.
There are three methodologies under the market approach that use transactions as indications of the market value:
1. Guideline Public Company Method—based on reasonably comparable publicly traded companies.
2. Guideline Company Transaction Method—based on transactions of reasonably comparable private companies reported in various databases.
3. Direct Market Data Method (DMDM)—based on a significant number of private transactions reported in various databases that purport to represent the market.
Data sources provide financial and other information, which can be used to determine whether the companies are suitable as guideline companies. This information can also be used to understand industry norms. The market approach is the most common approach employed by real estate appraisers, referred to as the sales comparison approach in real estate appraisals. Real estate appraisers, ...