Explain market approach (relative value) in mergers and acquisitions

In market approach, valuation of business (intangible assets, ownership interest, etc.) are determined based on market price of similar assets/business that are sold in recent times/available in market.

Sales, book value and P/E (price to earnings) are used as price indicators. After comparing with similar assets/business adjustments to qualities, quantities and size will be made.

Methods

The methods in market approach are as follows −

• Public company comparable

This method uses valuation metrics of publicly traded companies. Direct comparability is hard to attain in major situations. Selecting, adjusting and applying are complex processes, and need highly skilled, and experienced people to handle it. Guideline companies are those companies that traded publicly in similar industries and have practical basis in subject evaluation.

• Precedent transactions

Value is derived based on pricing multiples, which are based on transactions (observed) of the company. These are analyzed through conventional methods like SIC Codes. If there is no direct comparability, other data is used after considering those things as their products/market. This method is also used in exit strategy.

Factors

Factors to be considered in market approach are as follows −

• Companies (operating) in the same sector/industry.
• Same size.
• Similar products/services.
• Location.
• Operating in multiple sectors/industries.
• Profits.

Advantages

The advantages of market approach are as follows −

• Easy calculations.
• Independent of subjective forecasts.
• Data is real and public.

Disadvantages

The disadvantages of market approach are as follows −

• Less flexible.
• Data availability.
• Difficult to identify similar transactions to compare.
• We have to check if the data available is up to date or any old data is being used or in other words we have to check the validity of the data available.