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Business Valuation and Federal Taxes: Procedure, Law and Perspective, 2nd Edition by Shannon P. Pratt, David Laro

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Chapter 16

The Market Approach

Summary

Although the income approach as addressed in the previous chapter is theoretically the best approach to business valuation, it requires estimates (the projections and the discount rate) that are subject to potential disagreement. The market approach is quite different in that it relies on more observable data, although there can be (and often are) disagreements as to the comparability of the guideline companies used and the appropriate adjustments to the observed multiples to reach a selected multiple to apply to the subject company's fundamental data. There can also be disagreements as to which multiples to use (e.g., multples of sells, multiples of EBITDA, etc.) and the weight to accord each.

The Market Approach

The market approach to business valuation is a pragmatic way to value businesses, essentially by comparison to the prices at which other similar businesses or business interests changed hands in arm's-length transactions. It is widely used by buyers, sellers, investment bankers, brokers, and business appraisers.

The market approach to business valuation has its roots in real estate appraisal, where it is known as the comparable sales method. The fundamental idea is to identify the prices at which other similar properties changed hands in order to provide guidance in valuing the property that is the subject of the appraisal.

Of course, business appraisal is much more complicated than real estate appraisal because there are many more ...

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