Market Approach

Understanding the Market Approach

The market approach estimates value by observing actual sale prices of comparable companies or assets and then adjusting for meaningful differences.

When dependable relevant data exists, this approach can provide one of the most persuasive indications of value. However, the lack of trustworthy market data is a frequent problem.

In business appraisals, the market approach is frequently paired with the asset approach and/or the income approach to arrive at a credible and nuanced valuation.

Below, we walk through how the market approach is applied in business valuation.

Where the Market Approach Fits Best

The market approach often suits small to mid-sized companies, especially when there’s a healthy supply of comparable transactions in an active regional market.

It’s common in M&A, buy/sell situations, and valuations prepared for investment, tax, or legal purposes.

This method can be used for profitable and unprofitable companies, though it’s typically a poor fit for start-ups due to limited comparable sales.

Applying the Market Approach Step-by-Step

At a high level, the process looks like this:

1. Confirm that sufficient comparable sales exist.
2. Vet the data for accuracy and relevance.
3. Filter out statistical outliers.
4. Benchmark the subject against recent, similar transactions.
5. Where appropriate, cross-check findings with the asset and/or income approaches.

1) Confirm sufficient comparable data

Begin by ensuring there’s enough transaction evidence to support sound comparisons. If the dataset is thin or inconsistent, rely more heavily on alternative approaches.

2) Vet and clean the dataset

Next, validate the inputs. Typical fields include EBITDA, margins, net income, and deal terms.

Because many datasets originate from broker reports, quality can vary. Confirm whether EBITDA is adjusted, whether statements are reviewed or audited, and the exact periods covered.

If the underlying figures are unreliable, the comparisons will be too.

3) Identify and exclude outliers

Remove outlier transactions that can distort multiples and produce misleading indications of value.

4) Benchmark against recent comparable sales

With a cleaned dataset, compare the subject to similar, recently sold businesses.

Apply relevant multiples, commonly EBITDA or P/E, to estimate a reasonable range for fair market value.

5) Cross-check with other approaches

When data is limited, or to strengthen conclusions, pair the market approach with the income and/or asset approaches.

The market approach is powerful in concept, but execution matters. Treat your sources critically to avoid a false sense of precision.

A Simple Walk-Through Example

Here’s a streamlined illustration of the market approach in a business valuation. It’s simplified to demonstrate the idea.

Scenario:

You’re evaluating a small coffee shop in Miami, Florida. The asking price is $245,000. The location is strong, but the space needs cosmetic updates. There’s minimal online presence, though the shop serves a steady neighborhood clientele.

You suspect the ask is rich, so you gather recent transactions for comparable shops in the area (all closed within the past year).

Comparable sales (summary):

Next, compute the price-to-EBITDA multiple for each sale and evaluate the range.

Multiples derived from the data:

The average multiple is roughly 8.0x EBITDA. If the target shop’s normalized EBITDA is $27,500, an indicated value would be:

$27,500 × 8.0 = $220,000

Against an asking price of $245,000, the business appears somewhat overvalued on a market-multiple basis.

Noting that higher-priced comparables tend to have stronger digital reach and newer buildouts, you emphasize the subject’s limited online presence and the cosmetic work needed, then offer $222,000. After negotiations, the seller agrees.