Every business owner or entrepreneur, at some point, feels they should know the value of their business. When it comes to business valuations, the choice of the method solely depends on the purpose of the valuation and the unique characteristics of a business, as the process is highly complex.
The market approach, along with the asset and income approaches, is a widely used method for valuing businesses.
This guide helps business owners and entrepreneurs understand the market approach, its methods, and real-world applications for accurate business valuation.
What is the Market Approach Method in Valuation?
The market approach is a valuation method for estimating the appraised value of a business, intangible asset, ownership interest in a business, or security by comparing the market prices of similar assets or businesses sold very recently or still available. Price-related metrics such as book value, sales, and the price-to-earnings ratio are commonly used to help make adjustments for differences between the asset and comparables.
Market valuation approaches determine an asset’s fair value by comparing it to the prices of similar assets, adjusted for differences in number, quality, or size. For example, when valuing a share, it takes the most recent selling price for such comparable shares. Given that ownership shares in a company are almost completely identical, this method ends up giving a fair estimate of their fair market value.
How Does the Market Approach to Valuation Work?
The market approach, as its name implies, is used to determine: “What is the fair market value of this asset?” To answer this, you have to conduct a review of recent transactions that involve comparable assets. Due to the likelihood that these assets will not be identical to the asset being valued, a variety of modifications will be necessary.
- Public stocks and housing markets: Within the realms of public stocks and real estate, the market approach is applied easily on account of the enormous availability of transaction data.
- Challenges in Private Shares or Alternative Markets: In contrast, valuing assets like private company shares, fine art, or wine becomes a challenging task because comparable transactions are very few.
- Alternatives Used: In the absence of sufficient market data, valuators may estimate fair value by discounting cash flows (a DCF approach) or referring to the cost approach.
The market approach is advantageous because it is based on transaction data that is publicly available and comparable. This, therefore, allows it to have fewer subjective assumptions than others. The major disadvantage of the market approach, however, is that it can sometimes be impractical when there are no or very few comparable transactions, such as a private corporation in a niche market with few competitors.
Market Value Approach Example
This is an example that illustrates how the Market Value Approach can be used to determine if a business’s asking price is fair by comparing it to other businesses that were recently sold in the market.
You are interested in acquiring a small bakery business in a given city. The bakery is asking for $400,000, has been in existence for five years, has a loyal customer base, and has a steady revenue flow. Equipment is somewhat outdated, whereas the location of the business, being just moderately desirable, is not in a high-traffic area.
To determine the fairness of the asking price, you conducted research on the recent sales of bakeries that would be comparable to the one being considered.
To do so, you research recent sales of similar bakeries in your area and create a comparison table:
| Comparable Transactions | Price | Annual Revenue | Equipment Status | Quality of Location | Years of Operation | Customer Base |
| Bakery A | $450,000 | $500,000 | Modern | High-Traffic | 7 | Large |
| Bakery B | $380,000 | $450,000 | Modern | Medium-Traffic | 5 | Medium |
| Bakery c | $320,000 | $400,000 | Outdated | Low-Traffic | 6 | Small |
| Bakery D | $500,000 | $550,000 | Modern | High-Traffic | 8 | Large |
| Bakery E | $350,000 | $420,000 | Outdated | Medium-Traffic | 4 | Medium |
From the results above, you realize that bakeries with new equipment and high-traffic locations range between $450,000-$500,000, while those with outdated equipment and less foot traffic range between $320,000-$380,000.
The potential bakery is outdated and located in a medium-traffic area—not as good as high-traffic neighborhoods, but better than low-traffic ones. It is known to have loyal customers, but we do not know how many customers there are, thereby increasing uncertainty in evaluating its impact. With the above factors in mind, the $400,000 asking price seems to be somewhat on the high side. Based on this analysis, you choose to negotiate an offer of $350,000, which is more aligned with fair market value.
This example represents the market value approach using comparative sales data to measure the fair price of an asset while considering key business factors: location, condition of equipment, number of years in business, and customer base. In conjunction with market research, price negotiation represents a significant avenue for developing an informed investment decision.
Market Approach Methods
A valuation analyst may implement numerous valuation methodologies within the context of the market approach. The methodologies are named based on the source of known values that are used as guidelines. The market approach employs two primary valuation methods:
Public Company Comparables
The Public Company Comparables Method consists of using valuation metrics from publicly traded companies that are deemed to be appropriately comparable to the subject entity. Direct comparability is typically challenging to achieve in the majority of cases, as the subject is not only larger but also more dissimilar to the majority of public companies.
However, the direct comparability threshold should be somewhat lenient to ensure that public companies with comparable business features are not excluded from providing guidance on the valuation of the subject company.
In only a small number of industries, direct comparability is feasible. Most of them are confronted with the challenges of scalar differences that exist between the majority of private enterprises and public operators. Choosing, modifying, and using public company valuation data is a complicated process that requires a skilled and experienced appraiser.
Companies that have been publicly traded in a comparable or equivalent industry to the subject company are typically referred to as “guideline companies.” Additionally, they should have a practical foundation for comparison with the subject of evaluation due to the similarities in financial composition, operational processes, and demand and supply factors.
Public Company Comparables Method Example
Based on the financial data of similar public companies, we are determining the value of TargetCo Inc. in the Food & Beverage Industry. Here’s how we do the calculation using their data.
Comparison Companies:
Company | Market Capitalization ($) | Enterprise Value (EV) ($) | Revenue ($) | EBITDA ($) | Net Income ($) |
| SnackWorld Corp. | 45.256 B | 55.312 B | 20.500 B | 4.215 B | 1.823 B |
| Beverage Plus Ltd. | 22.321 B | 26.245 B | 10.125 B | 2.350 B | 1.125 B |
| Foodie Brands Inc. | 68.750 B | 81.500 B | 45.875 B | 8.125 B | 4.500 B |
Next, we figure out the valuation ratios for each company:
Company | EV / Revenue | EV / EBITDA | P / E Ratio= Market Cap / Net Income |
| SnackWorld Corp. | 2.7 | 13.1 | 24.8 |
| Beverage Plus Ltd. | 2.6 | 11.2 | 20.0 |
| Foodie Brands Inc. | 1.8 | 10.0 | 15.3 |
Now, we find the average ratios for each category:
| Multiple | Values | Average multiple |
| EV / Revenue | 2.7, 2.6, 1.8 | 2.4 |
| EV / EBITDA | 13.1, 11.2, 10.0 | 11.4 |
| P / E Ratio | 24.8, 20.0, 15.3 | 20.0 |
Now, apply average multiples to TargetCo Inc.
| Valuation Method | Multiple | Calculation | Implied Value |
| EV / Revenue | 2.4 | 2.4 × $4.500 B (Revenue) | $10.8 B (EV) |
| EV / EBITDA | 11.4 | 11.4 × $520 M (EBITDA) | $5.9 B (EV) |
| P / E Ratio | 20.0 | 20.0 × $260 M (Net Income) | $5.2 B (Market Cap) |
Result:
Using the Public Company Comparables Method, the value of TargetCo Inc. is:
- Enterprise Value (EV): Between $5.9 billion and $10.8 billion
- Market Value (Market Cap): $5.2 billion
Source: This example is based on information from Eqvista.
Precedent Transactions
Value is derived through the Precedent Transactions Method, which is based on pricing multiples that are determined by the transactions of companies in the subject company’s industry. It is predicated on the belief that comprehensive company financial data is not readily accessible, but transaction value is readily accessible.
Precedent transactions can be analyzed using standard industry classification methods such as SIC codes. In addition, valuation databases can be accessed to verify historical actuals and valuation. Such transactions may involve a majority or minority stake.
A transaction that serves as a decent guideline should be conducted with a company that is highly comparable in the same industry. In situations where there is no direct comparability, alternative data may be employed; however, it is imperative to consider factors such as their market or products before doing so.
However, under certain conditions, such as considering a purchase or sale or an exit strategy from the company’s management, the transaction method would prove useful. Obviously, one of the potential weaknesses is that some transactions may have occurred under market or industry conditions different from those at the time of the current acquisition and merger. Therefore, it may not apply all that much. Besides that, when there isn’t enough information in the public spectrum or research databases, it makes it tough to understand whether any transaction is appropriate enough to be compared.
Precedent Transactions Method Example
Let’s consider the company NexaTech Solutions as an example so that we can determine its value using assumed precedent transaction values from the technology sector. We will determine the value of NexaTech Solutions by analyzing the transaction data.
| Transaction Year | Company Acquired | Acquirer | Transaction/Enterprise Value (EV) | Revenue ($) | EBITDA ($) | Net Income ($) |
| 2024 | Innovarix Systems | Voltura Enterprises | $8.5 B | $2.2 B | $500 M | $150 M |
| 2024 | Bytevex Technologies | Strativan Group | $4.5 B | $1.8 B | $350 M | $120 M |
| 2024 | Digitalex Solutions | Nexum Labs | $6.0 B | $2.0 B | $400 M | $130 M |
Next, we will calculate the transaction multiples using the data from the table:
| Company Acquired | EV/Revenue | EV/EBITDA | P/E Ratio = EV / Net Income |
| Innovarix Systems | 3.9 | 17.0 | 56.7 |
| Bytevex Technologies | 2.5 | 12.9 | 37.5 |
| Digitalex Solutions | 3.0 | 15.0 | 46.2 |
* Assuming EV = Market Cap
Now, we calculate the average transaction multiples:
| Valuation Metric | Values | Average |
| EV / Revenue | 3.9, 2.5, 3.0 | 3.1 |
| EV / EBITDA | 17.0, 12.9, 15.0 | 15.0 |
| P / E Ratio | 56.7, 37.5, 46.2 | 46.8 |
Next, we will apply these multiples to NexaTech Solutions.
| Valuation Method | Multiple Used | Calculation | Implied Value |
| EV / Revenue | 3.1 | 3.1 × $2.5 B (Revenue) | $7.8 B (Enterprise Value) |
| EV / EBITDA | 14.0 | 15.0 × $400 M (EBITDA) | $6.0 B (Enterprise Value) |
| P / E Ratio | 46.8 | 46.8 × $120 M (Net Income) | $5.6 B (Market Cap) |
Result:
Using the Precedent Transactions Method, the worth of NexaTech Solutions is:
- Enterprise Value (EV): Between $6.0 billion and $7.8 billion
- Market Value (Market Cap): $5.6 billion
Source: This example is based on information from Eqvista.
In both of the aforementioned market valuation methods, the primary objective is to identify companies that are sufficiently comparable to the subject company under valuation. When determining whether a company is comparable enough to be used in determining the value of another company, the appraiser should consider a variety of factors, including:
- Companies that are engaged in the same industry
- Whether they are comparable in size
- Whether they provide identical services or products
- Whether any of the companies work in multiple industry sectors
- The companies’ locations
- Whether they compete for the same business
- Whether or not they possess comparable profits
Key Applications of the Market Value Approach
The market approach is particularly appropriate for determining the value of your business in the following scenarios:
- When you wish to establish the asking price or offer price for a business acquisition.
- When you are required to defend the valuation of your business in a legal dispute or before the tax authorities.
- This is for the purpose of justifying the value of your business in the event of a dispute, such as an acquisition or partner disagreement.
Strengthen Your Business Value with Precise Valuations
Understanding business valuation through the market approach provides entrepreneurs and business owners with a practical method to assess the worth of their company. By analyzing comparable sales data, they can determine whether to purchase, sell, or defend the value of their company. A market-based approach yields valuable insight in either public comparables or precedent transactions. However, achieving accuracy and consistency in valuation requires professional expertise, as it is often a complex process.
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