20 Apr The Market Approach: Deeper Dive on Databases and Filtering for Comparable Transactions
Written by: Ally Yan, CVA
(5-7 minute read)
The market approach is one of the fundamental approaches in a fair market value appraisal. This approach uses past transaction data as comparables to determine the fair market value of the subject company. The methods that are most often used under this approach are the Guideline Public Company Method (GPCM) and Guideline Merger and Acquisition Method (Transaction Data Method). GPCM uses the price of publicly traded stock and publicly traded company data to determine the value of closely held businesses. The Transaction Data Method is similar to GPCM but instead uses valuation multiples from actual transactions of privately held companies that are comparable to the subject business. Advantages of the market approach include being user friendly, relatively simple to apply, using empirical data, and no reliance on forecasts. However, disadvantages include being costly, less adaptable compared to other approaches, and a potential lack of comparable data.
Generally, when valuing small to medium sized closely held businesses, the Guideline Merger and Acquisition Method is used. However, it can be applied by using public company or private company data. Under this method, databases of completed transactions, such as DealStats and BIZCOMPS, can be used. These databases are generally populated by a network of business brokers, M&A advisors, and intermediaries, and the data dates back decades.
The size of the company, the industry in which it operates, and many other factors can impact the multiple at which companies are sold. Using market data that is not comparable to the company can result in inaccurate conclusions. Therefore, the databases are filtered based on a few categories to narrow down the transactions to ones that would be most comparable to the subject company. These categories can include:
Industry selection
- Filter using the same (or similar) NAICS / SIC codes that the subject company is classified as
Business description
- Include only companies that provide similar products/services
Sale date
- Filter based on a select number of years prior to the effective date
Company Size
- Filter to a range of sales that is comparable to the subject company
MVIC/Sales, MVIC/EBITDA, and MVIC/SDE
- Remove any outliers
Once the transactions are filtered and the comparables are found, the Appraiser will determine the percentile that the subject company falls in. This is based on the subject company’s sales, EBITDA, SDE, growth, company specific risk, and other factors compared to the transactions within that percentile. For example, if the company’s sales and earnings are in line with the comparables in the 75th percentile, but the business has significant customer concentration, the appraiser may use the 50th percentile instead.
Another example is shown below of the filtered transactions in the DealStats database of a restaurant. The subject company’s forecasted sales, EBITDA and SDE are similar to those of the comparable transactions at the 85th percentile (the other factors listed above are also taken into account when determining the percentile).
The multiples (Price/Sales, Price/EBITDA and Price/SDE) determined by the utilized databases will be applied to the subject company’s sales and earnings to calculate separate indications of value. Generally, the Appraiser will apply weight to Price/EBITDA and Price/SDE multiples, with the most weight being applied to the dataset(s) deemed to be most reliable. (Read this article for more information regarding the different multiples.) This is based on the number of comparable transactions, the coefficient of variance for each set of data, and which data set most closely resembles the business’s operations.
Coefficient of variance is a measure of how consistent a set of data is. Therefore, the lower coefficient of variance, the more reliable the method is. For example, if data set A has a coefficient of variance of 0.2 and data set B has a coefficient of variance of 0.6, the appraiser should consider putting more weight to data set A.
The chart below shows the summary of the values and weight applied to each multiple (for the same restaurant mentioned earlier) utilizing DealStats and BizComps.
In this case, the Appraiser applied less weight to the Price/EBITDA multiple due to the high coefficient of variance. Additionally, the Appraiser deemed the Price/SDE multiples to be more appropriate for a business of this size operating within the restaurant industry.
The Market Approach emphasizes the principle of substitution. Past transactions of private companies are analyzed and filtered to determine an indicated value for the subject company. If there are enough comparable transactions and they are deemed reasonable comparisons to the subject company, the appraiser will likely apply weight to this approach. The final value, however, can be a weighted average between multiple approaches.