The Market Approach to Valuing Businesses

by Shannon P. Pratt

• ISBN13: 9780471359289
• ISBN10: 0471359289
• Format: Hardcover
• Copyright: 2001-01-01
• Publisher: Wiley

Summary

Your Best Approach to Determining Value If you're buying, selling, or valuing a business, how can you determine its true value? By basing it on present market conditions and sales of similar businesses. The "market approach" to valuing businesses is quickly becoming popular for determining the value of a business or partnership. Praised for its objectivity, the approach is the model most favored by the IRS and the United States Tax Court-as long as it's properly implemented. With Shannon Pratt's The Market Approach to Valuing Businesses, buyers and sellers can best ensure effective market approach implementation. Designed for anyone who needs to carry out or review a market approach to valuation, this book serves as both practical tutorial and handy desk reference. In this comprehensive guide, you'll find information on valuing and its applications, case studies on small and midsize businesses, and a detailed analysis of the latest market approach developments as well as: A critique of U.S. acquisitions over the last 20 years An analysis of the effect of size on value Common errors in applying the market approach Court reactions to the market approach Must-reading for anyone who owns or holds a partial interest in a small or large business or a professional practice, The Market Approach to Valuing Businesses will show you how to successfully reach a fair agreement. www.wiley.com/accounting

Author Biography

SHANNON P. PRATT is a founder and managing director of Willamette Management Associates, the managing owner of Business Valuation Resources, LLC, and a member of the board of directors of Paulson Capital Corp. He holds a doctorate in business administration from Indiana University. Dr. Pratt is author of Business Valuation Body of Knowledge: Exam Review and Professional Reference (Wiley); Cost of Capital: Estimation and Applications (Wiley); and The Lawyers Business Valuation Handbook. He is coauthor of Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Fourth Edition; Valuing Small Businesses and Professional Practices, Third Edition; and Guide to Business Valuations, Tenth Edition. <P>Contributors: <P>STACY ISON (&quot;The Market Approach in the Courts,&quot; Chapter 19) is managing editor of Shannon Pratt&#146;s Business Valuation Update&trade;. DOUG TWITCHELL (&quot;Comparative Financial Analysis,&quot; Chapter 8; &quot;Compiling Useful Market Value Tables,&quot; Chapter 9) and CHAD PHILLIPS (sample cases, Chapters 13 and 14) are comanagers of Pratt&#146;s Stats&trade;. ALINA NICULITA, an intern at Business Valuation Resources, LLC, prepared Appendices A and B. Z. CHRISTOPHER MERCER (&quot;The Quantitative Marketability Discount Model,&quot; Appendix D) is CEO of the Mercer Capital business appraisal firm. PAUL HEIDT, a financial analyst at Business Valuation Resources, LLC, compiled Appendix E.

Table of Contents

List of Exhibits	xv
Foreword	xix
Preface	xxi
Acknowledgments	xxv
Notation System Used in This Book	xxix
Introduction	xxxiii
Part I. Defining Market Multiples and Market Approach Methods	1	(48)
Defining Market Value Multiples	3	(21)
Common Equity Only versus Total Invested Capital Multiples	4	(5)
Computing Market Value of Equity Multiples	9	(1)
Commonly Used Market Value of Equity Multiples	9	(5)
Computing Market Value of Invested Capital (MVIC) Multiples	14	(2)
Commonly used MVIC Multiples	16	(4)
Time Periods to Measure Financial Variables	20	(1)
Relationship between Market Multiples and Capitalization Rates	21	(1)
Summary	22	(2)
The Guideline Public Company Method	24	(9)
Scope of Market	25	(1)
Availability of Public Company Data	26	(2)
Analytical Data for Public Companies	28	(1)
The Guideline Pubic Company Basic Procedure	29	(2)
Premiums and Discounts	31	(1)
Summary	31	(2)
The Guideline Merged and Acquired Company Method	33	(9)
Differences in Transaction Structure	34	(1)
Scope of Market	35	(1)
Availability of Merged and Acquired Company Transaction Data	36	(2)
How Far Back in Time Are Transactions Relevant?	38	(1)
The Guideline Merger and Acquisition Basic Procedure	38	(1)
Premiums and Discounts	39	(1)
Summary	40	(2)
Other Market Methods	42	(7)
Past Transactions	42	(2)
Offers to Buy	44	(1)
Rules of Thumb	44	(2)
Buy-Sell Agreements	46	(1)
Summary	47	(2)
Part II. Finding and Analyzing Comparative Market Transaction Data	49	(66)
Finding Public Company Market Transaction Data	51	(4)
EDGAR	51	(1)
Secondary Sources for SEC Reporting Companies	52	(1)
Publicly Registered Limited Partnership Data	53	(1)
Sources for Nonreporting Companies	53	(1)
Summary	54	(1)
Finding Merger and Acquisition Market Data	55	(17)
Large Transactions	56	(2)
Middle Market and Small Transactions	58	(4)
Very Small Transactions	62	(9)
Summary	71	(1)
Adjusting Financial Statements	72	(9)
Choosing the Time Periods for Comparative Statements	73	(1)
Objectives of Financial Statement Adjustments	74	(1)
Adjustments for Nonoperating or Excess Assets	75	(1)
Nonrecurring Items	76	(1)
Adjustments for Accounting Comparability	77	(2)
Adjustments for ``Insider'' Anomalies	79	(1)
Summary	80	(1)
Comparative Financial Analysis	81	(34)
Types of Comparative Financial Analysis	82	(1)
Sources of Comparative Financial Analysis	83	(13)
Types of Ratios	96	(16)
Summary	112	(3)
Part III. Compiling Market Value Tables and Reaching a Value Conclusion	115	(42)
Compiling Useful Market Value Tables	117	(14)
Two Distinct Alternatives in Market Multiples	118	(1)
Examples of Market Value Tables	119	(8)
Summary	127	(4)
Selecting, Weighting, and Adjusting Market Value Multiples	131	(5)
Size and Nature of Company	131	(1)
Availability of Data	132	(1)
Dispersion of Market Value Multiples	133	(1)
The Harmonic Mean as a Measure of Central Tendency	133	(1)
Adjusting from Observed Market Value Multiples	134	(1)
Summary	135	(1)
Control Premiums and Minority Discounts	136	(9)
Prerogatives of Control Ownership	137	(1)
Quantifying Control Premiums and Minority Discounts	138	(3)
How the Standard of Value Affects Control Premiums and/or Minority Discounts	141	(2)
The Control versus Minority Issue Covers a Spectrum	143	(1)
Summary	144	(1)
Discounts for lack of Marketability	145	(12)
Defining Discount for Lack of Marketability	145	(1)
Applying the Discount for Lack of Marketability	146	(1)
Market Evidence Regarding the Discount for Lack of Marketability for Minority Interests	147	(3)
Regulatory and Court Acceptance of Empirical Lack of Marketability Studies	150	(2)
Factors Affecting Magnitudes of Marketability Discounts	152	(1)
Discounts for Lack of Marketability for Controlling Interests	153	(1)
Summary	154	(3)
Part IV. Sample Market Approach Cases	157	(72)
Small-Size Service Company Sample Case--Sub Shop	159	(26)
Business Description	159	(1)
Valuation Assignment	160	(1)
Economic Outlook	160	(1)
Financial Statement Analysis	160	(7)
Identification and Selection of Market Data	167	(13)
Identification and Selection of Valuation Multiples	180	(1)
Valuation of Wildcat Subs	181	(3)
Reconciling Value Conclusions	184	(1)
Addendum if Valuing for Other Purposes	184	(1)
Medium-Size Service Company Sample Case--Software Developer	185	(44)
Valuation Assignment	186	(1)
Economic Outlook	187	(1)
Fundamental Position of the Company	188	(2)
Selection of Market Data	190	(3)
Financial Statement Analysis	193	(18)
Identification and Application of Valuation Multiples	211	(11)
Valuation of Colossal Software	222	(7)
Part V. Important Aspects of Using the Market Approach	229	(48)
Reconciling Market Approach Values with Income and Asset Approach Values	231	(11)
Did We Appraise the Correct Property?	231	(1)
Conformance to the Required Definition of Value	232	(1)
Relative Adequacy and Reliability of Data	232	(1)
Check for Errors	233	(1)
Check Assumptions	233	(1)
Relationship between Market Multiples and Discount or Capitalization Rates	233	(4)
What to Do When Reconciliation Efforts Fail	237	(2)
Explicit versus Implicit Weighting	239	(1)
Summary	240	(2)
Does Size Matter? Evidence from Empirical Data	242	(10)
Evidence from Market Approach Data	242	(1)
Evidence from Income Approach Data	243	(8)
Summary	251	(1)
Common Errors in Implementing the Market Approach	252	(11)
Inadequate Selection of Guideline Companies	253	(1)
Indiscriminate Use of Average (or Median) Multiples	254	(1)
Failing to Consider Guideline Company Financial Statement Adjustments	254	(1)
Failure to Conduct a Site Visit and Management Reviews	255	(1)
Making Inappropriate or Unsupported Financial Statement Adjustments	256	(1)
Applying Multiples to Inconsistently Defined Data	257	(1)
Failure to Match Time Periods	257	(1)
Reliance on Rules of Thumb	258	(1)
Failure to Account for Excess or Deficient Cash	259	(1)
Failure to Adjust for Differences in Deal Terms and Structure	260	(1)
``Assets Plus...'' Rules	261	(1)
Failing to Apply Appropriate Discounts and Premiums	261	(1)
Summary	262	(1)
The Dismal Track Record to U.S. Market Acquisitions	263	(6)
Acquires Tend to Overpay	263	(2)
Why Buyers Overpay: The Hubris Effect	265	(2)
The Frog-Kissing Princess	267	(1)
Summary	268	(1)
The Market Approach in the Courts	269	(8)
U.S. Tax Court	269	(4)
Marital Dissolutions	273	(1)
Dissenting Stockholder, Minority Oppression, and Other Shareholder Disputes	273	(2)
Summary	275	(2)
Appendixes	277	(58)
Appendixes A Bibliography	279	(10)
Appendixes B Data Resources	289	(21)
Appendixes C International Glossary of Business Valuation Terms	310	(8)
Appendixes D The Quantitative Marketability Discount Model	318	(11)
Appendixes E Pratt's Stats Data Contributors	329	(6)
CPE Self-Study Examination	335	(10)
Index	345