1. http://www.valuadder.com/blog/2010/12/22/valuation-multiples-and-guideline-
public-company-method/
Overview of the Market Approach
Business valuation techniques are often characterized as being based on one of three
approaches: the cost or asset approach, the income approach, and the market approach.
Thus, the market approach undoubtedly is one of the standard methods/approaches of
valuation. The market approach to business valuation is rooted in the economic principle of
competition: that is in a free market the supply and demand forces will drive the price of
business assets to a certain equilibrium. Buyers would not pay more for the business, and the
sellers will not accept less, than the price of a comparable business enterprise. This method
generally involves finding a representative multiple of value to a financial measure from a set
of guideline (or peer or comparable) companies and applying that multiple to the financial
measure of the company being valued.
While there are no definitive guidelines on how to implement the market approach, the
generally accepted series of steps can be listed as follows: first, the appraiser selects publicly
traded companies that he or she believes are similar in nature to the company being valued.
In addition to selecting companies, the appraiser may also examine transactions in which a
company was purchased. Next, the appraiser selects relevant financial measures for the
reference or guideline companies, such as revenues, earnings, or EBITDA. Then he/she
finds the multiple for each financial measure (i.e., the ratio of company value to the level of
the financial measure for that company) for each guideline company. This process gives the
appraiser a dataset of multiples, from which he/she can select a representative multiple, such
as the mean, median or any other reasonable statistical measure of central tendency of the
guideline companies’ multiples.
The appraiser then takes this representative multiple and applies it to the financial measure
of the company being valued. If necessary, he/she adjusts that financial measure to account
for extraordinary events. Finally, the appraiser considers whether any premiums or
discounts, such as control premiums or discounts for lack of marketability, are warranted.

2. The Selection of Guideline Companies or Transactions
As discussed above, the selection of guideline companies or transactions is often considered
the first step in a market approach to valuation. In practice, the guideline companies are
generally chosen by an appraiser using his or her knowledge of the company to be valued,
any knowledge they have about the industry, and a great deal of subjective decision-making.
For this purpose, usually valuators define guideline public companies as companies similar to
the subject company that trade freely in the public market on a daily basis—with similarity
measured by comparable nature of the operations and comparable key financial
characteristics. As a publicly traded company, the guideline company provides a value based
on active daily trading. Combining this pricing objectivity with the regulatory reporting
requirements and analytical information required of publicly traded companies, much
information can be known about a public company. If it can be determined that the subject
company is comparable, an argument can be constructed asserting that the guideline public
company’s daily trading price provides a reasonable basis for an opinion of value for the
subject company.
This method entails a comparison of the subject company to publicly traded companies. The
comparison is generally based on published data regarding the public companies’ stock price
and earnings, sales, or revenues, which is expressed as a fraction known as a “multiple.” If
the guideline public companies are sufficiently similar to each other and the subject company
to permit a meaningful comparison, then their multiples should be similar. However, in
practice such is not the case to be found. The public companies identified for comparison
purposes should be near similar if not identical to the subject company in terms of industry,
product lines, market, growth, margins and risk.
Thus, the underlying objective of the guideline public company method is to derive multiples
to apply to the fundamental financial variables of the subject company. These fundamental
financial variables may be either balance sheet amounts or operating variables derived from
income statements. Based on the comparative analysis between the guideline and subject
company, as well as site visits, management interviews, and the nature of the industry, the
valuator chooses the valuation multiples to rely on.

3. There are, however, fundamental differences between publicly traded and privately owned
companies. These differences are frequently too significant to allow for the proper
application of this methodology. Four of the most significant differences are:
• Public stock prices are marketable, minority ownership interests. The share price
reflects the value to a minority interest owner who exercises no control over the
company’s operations. By contrast, many small businesses are wholly owned and
controlled by a small number of investors. A single investor can exert significant
control over the company’s operations.
• Public companies are run by boards of directors and professional managers.
Corporate objectives are clearly stated and designed to maximize shareholder value.
By contrast, a family owned business may have a narrower corporate objective to
minimize taxes or maintain key supplier or customer relationships.
• Public companies typically have better access to capital allowing for maximization of
growth potential and diversification opportunities. A small business without similar
access to capital may not be able to achieve the same growth and diversification
opportunities.
• Public companies maintain detailed information systems to document goals,
directions, and expectations. Detailed budgets and strategic plans are prepared for
the next one, five, and ten years. A small business may have a one-year operating
budget and a “wish list” capital budget. Comparing the public company’s historical
and projected results to the subject company’s historical and projected results may
not be possible due to lack of subject company information.
Frequently, valuator experience and professional judgment can be applied to reconcile these
differences. Discussions with management can lead to mining valuable data necessary to
establish the subject company’s comparability to the public company. This effort to establish
comparability will allow the public company to serve as a guide in determining the subject
company’s value.
However, the difficulty lies in identifying public companies that are sufficiently comparable
to the subject company for this purpose. Also, as for a private company, the equity is less

4. liquid (in other words its stocks are less easy to buy or sell) than for a public company, its
value is considered to be slightly lower than such a market-based valuation would give.
The Selection of Multiples
Once the selection of the guideline companies or transactions is made, appraisers often next
turn to the selection of the relevant financial measures for computing multiples.
This method takes into account the traded or transaction value of comparable companies in
the industry and benchmarks it against certain parameters, like earnings, sales, etc. Two of
such commonly used parameters are:
· Earnings before Interest, Taxes, Depreciation & Amortizations (EBITDA).
· Sales/Revenues
Although the Market Multiples method captures most value elements of a business, it is
based on the past/current transaction or traded values and does not reflect the possible
changes in future of the trend of cash flows being generated by a business, neither takes into
account the time value of money adequately. At the same time it is a reflection of the current
view of the market and hence is considered as a useful rule of thumb, providing
reasonableness checks to valuations arrived at from other approaches.
There is often little discussion of the process for selecting the financial measures, and some
or all of the usual suspects—revenue, earnings, and EBITDA—tend to appear in most
valuations. Once the financial measures and the representative multiples are selected,
appraisers typically derive valuations for each of those measures.
For example, there may be an estimate of value based on revenue multiples, one based on
earnings multiples, and one based on EBITDA multiples. The final valuation conclusion is
often drawn by examining the individual valuations, either taken as a range or, with the

5. selection of a central measure of those individual valuations (e.g., the mean or the median, or
a weighted average), as the point estimate of the valuation.
Selecting the Representative Multiple: Potential Problems with
Making Subjective Adjustments
Another issue that arises in the selection of representative multiples is what to do when the
appraiser wishes to depart from some measure, such as the mean or median, of the “center”
of the distribution of guideline company multiples. This is possible when an appraiser
believes that a private company should be valued at a discount to the measures of central
tendency of a selected guideline group.
One way to accomplish this task would be to select a statistical measure other than the
median as the base multiple. For example, an appraiser might, based on comparisons of
revenues, growth, margins, leverage, or other factors, conclude that a private company
should most appropriately be compared with a specific portion of the entire guideline group,
for example, the lower half or the upper half of the group’s multiples, rather than the entire
group.
Now, because the representative multiple is derived from the bottom half of the multiples it
would result in a lower valuation than taking the median multiple, there should be a good
justification for ignoring half the data. This also begs the question of why the appraiser is
focused on the bottom 50% of the multiples, as opposed to the bottom 75% or the bottom
25%.
Ultimately, in this case how far the appraisal will be pushed down depends on how much or
how little of the bottom of the set of guideline companies the appraiser uses in his or her
calculation of the representative multiple.

6. In response to the concerns discussed above regarding what financial measures to examine,
one could use accepted statistical measures to see if the financial and other measures such as
revenues, growth, margins, or leverage do affect multiples in the guideline group. If so, then
an objective, statistically based adjustment could be made to the representative multiple,
based on the measures of those characteristics in the company to be valued. This type of
procedure would considerably reduce the subjectivity of the adjustment, and because it
would be performed under the controlling standards of a statistical analysis, it would yield
potential error rates.