The Art of Business Valuation

CHAPTER 6Market Approaches

The market method is a comparative method to estimate business value. Actual reported business sales are compared to the subject company's to estimate a value. The concept of market value is:

Cash flows used for business valuation are future cash flows. Future expectations drive price and value. This is similar to the fact that the public stock markets often move 18 months ahead of predicted economic change. While the past is studied in detail it is to better understand the future.

In the market method one or more cash flows are used as a proxy for the comparison. Frequently used cash flows include revenues, gross profit, profits, seller's discretionary earnings (SDE), and earnings before interest, taxation, depreciation, and amortization (EBITDA). A multiplier of cash flow will be applied against a cash flow to estimate a value.

Like most simple things, simplicity masks complexity. Let's be clear, the market method using revenues as a cash flow at the rule of thumb level is very simple. However, when carefully applied to properly adjusted cash flows, that are thoughtfully related to appropriate comparables at the opinion of value level, it is quite complex.

Interestingly, in business valuation, the use of the market method is looked down upon by many practitioners. This makes little sense. As a contrast, in real estate valuation, ignoring the market ...