Commonly used by real estate professionals, the market approach determines the value of a business by using an “industry average” multiplier. This industry average is based on the price at which comparable businesses have sold for. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. These formulas, often called Rules of Thumb, can be troublesome because they may not focus on the bottom line; profits, earnings, EBIT or EBITDA. If an industry Rule of Thumb says company XYZ is selling for 50% of its annual gross sales, would you pay 50% for those sales if the company was not profitable? In most cases, business people want to invest in something that is profitable, sustainable and stable enough to produce growth in the future. The market approach is key to opening the door to opportunities which allow you to make the best business choices.
The appraiser therefore tries to focus on industry formulae where they are applied to a multiple of earnings. This market approach is similar to analyzing a publicly traded company by its P/E (price to earnings) ratio.The approach, if enough empirical data is available, can very often be the most reliable valuation methodology for many industries. Central Business Brokers, because of its status as an appraisal and brokerage/intermediary firm, has an extensive data base of actual sales to draw upon. In addition, by means of membership, we also have access to many of the world’s largest data bases of done deals.
Here are a few industry multiplier examples:
- Retail (Family) 1/3 of annual sales
- Service Companies (General) 1.7 X annual net profit + inventory + equipment
- Manufacturing (Job Shop) 3-5 times EBITDA plus WIP – with patent, 4-6 times EBITDA