This time let's explore how to value businesses by looking at what similar companies are worth.

The market-based approach uses the wisdom of the marketplace. If Company A sold for $10 million, what does that tell us about similar Company B?

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Why do you think looking at similar companies would help determine value?

Market-based valuation relies on comparables, or "comps" as professionals call them. We find businesses similar to ours and see what they're trading for or what they sold for.

Think of it like pricing your house - you look at what similar homes in your neighborhood recently sold for.

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What makes two businesses "similar" in your opinion?

There are two main types of market comparables: trading comps and transaction comps.

Trading comps look at public companies currently trading on stock exchanges. Transaction comps examine recent sales of entire companies.

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Which type do you think gives more reliable data for valuing a business?

Market multiples are the key tool here. We take a company's value and divide by a financial metric like revenue or earnings.

If a software company sold for $20 million with $4 million revenue, that's a 5x revenue multiple.

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Can you calculate the revenue multiple if a company worth $30 million has $10 million revenue?

Here's how it works in practice: find three similar companies, calculate their multiples, then apply the average multiple to your company's financials.

If comparable companies trade at 3x revenue and your company has $5 million revenue, your estimated value is $15 million.

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Simple math, but what could go wrong with this approach?

The market approach works best when you have truly comparable companies and active market data. Technology startups, retail chains, and restaurants often have good comparable data.

But finding perfect matches can be challenging - every business has unique characteristics.

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What industries do you think would have the best comparable data?

The market approach has one major advantage: it reflects what real buyers and investors are actually paying. Unlike theoretical models, market data shows real transactions.

However, it assumes the market is pricing things correctly - which isn't always true!

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In a few words, what's one potential drawback of relying solely on market prices?

Type

Multiple Choice

Practice Question

TechCorp has $8 million in revenue. Comparable software companies recently sold at an average of 4x revenue. Using the market-based approach, what's TechCorp's estimated value?

A. $2 million
B. $12 million
C. $32 million
D. $4 million

Suggested Answers

• A
• B
• C - Correct
• D