Business Valuation – Guideline Companies

Business valuation is as much an art as it is a science. The “science” is a series of prescribed processes and analyses you need to perform on the path to reaching credible results, which most accountants (myself included) learn a classroom. The “art” comes from the significant professional judgement that must be applied to reach credible results.

This is part of a series to explore some of the complexities and nuances of business valuation in the context of litigation. In it, we refer to “The Science” and “The Art” of business valuation, generally referring to difference between the theoretical, prescriptive practice of business valuation and the more nuanced realities, respectively.

Guideline Companies and Transactions

One approach is to consider how the marketplace values similar companies. This can be done by both by considering (i) how much was paid to acquire the entirety of similar, closely-held companies, (ii) market capitalization of similar publicly-traded companies, or (iii) how much was paid to acquire shares of the subject company. These are broadly referred to as guideline companies or guideline transactions. Both are common practice and generally accepted within valuation circles.

Next step: select your guideline transactions. The Science makes this process easy: in a classroom seating, there are no shortage of companies sold or publicly traded companies that are similar to the subject company and close enough to the date of value to be meaningful applied. The Art is rarely so conveniences. For context, I struggled to write the viewpoint of The Science without laughing at the absurdity of it.

Once you’ve selected your guideline companies or transactions, they need to be expressed to your subject company. This is usually calculated as multiples. But how do you chose which of the guideline multiples to use? The Art once against is about knowing from experience. Things to consider (this is not intended to be an exhaustive list):

  1. More profitable company will demand a higher price multiple.
  1. How comparable are these companies? Sometimes there isn’t good market information available, necessity drives innovative thinking. These guideline transactions might be worth giving lesser weight.
  1. Ask your client. No matter how informed appraisers are, our clients are going to be more familiar and better informed regarding their business than we are.

Ultimately, the objective it to condense your guideline transactions down to a single multiple.

What’s left over?

For more information on this subject, consider reading the other articles in this series:

Absurd rhetorical device notwithstanding, business valuation is both a science and an art. The Science may tell you what to do, The Art is in knowing how to do it. The good news is there are any number of competent appraisers who can help you do just that.