Legal Counsel Considerations for Business Valuations Using the Guideline Transactions Method
The Guideline Transactions Method (“GTM”) is one of the methodologies available to business appraisers for valuing a business under the Market Approach. The concept underlying this method is that the value of a subject company can be estimated based upon recent transactions involving the purchase or sale of comparable companies that have occurred in the private or public marketplace. The implied pricing multiplies (e.g. Enterprise Value/EBITDA, Price/Net Income, etc.) from these transactions are calculated and then applied to the subject company’s applicable economic income metric to determine value. If sufficient and relevant information is available, the GTM may provide an estimate of value that is credible and more easily understood than other valuation approaches and methodologies.
Transaction Data Limitations
There are numerous databases that provide information on private and public transactions of businesses (e.g. DealStats, BIZCOMPS, ValuSource Market/M&A Comps, S&P Capital IQ, etc.). However, oftentimes these databases contain only a limited amount of information regarding transaction terms and financial results for the guideline company that was bought or sold, especially for transactions of private companies. Consequently, one of the major weaknesses of this approach is the difficulty in determining whether the guideline company involved in a transaction is truly comparable given the limited data available. Examples of relevant questions regarding transaction considerations and company-specific information that may not be properly answered by the data available in these databases are as follows:
- What was the purpose of the transaction? For example, was the transaction an arms-length transaction between independent parties, subject to a buy-sell agreement, etc.?
- What were the motivations of the buyers and sellers? For example, were expected synergies included in the price paid for a particular business? Was the buyer a financial buyer? Was this a distressed sale?
- What were the terms of the transaction?
- Was the transaction structured as a stock or asset deal? If it was an asset deal, what assets, if any, were retained by the seller?
- Was the transaction an all-cash deal, seller financed, or subject to any contingent consideration?
- Was there a noncompete agreement, employment contract, promises of perquisites, or other aspects to the transaction that would affect the actual price paid for the business?
- What was the corporate structure of the buyer and seller (e.g., C Corp., S Corp., LLC, or partnership)?
- Is there sufficient historical financial information available to permit analysis of trends and to identify potential normalization adjustments? If so, were the financial statements prepared by management or was any type of assurance provided by an independent CPA firm?
- What were the growth and profit expectations for the acquired business?
- Were there any specific company risk factors particular to the acquired business (e.g., depth of management, customer or supplier concentration, etc.)?
- What were the specific products or services offered and geographic markets served by the acquired business?
- When did the transaction occur and does the transaction multiple reflect current economic, industry, and market conditions?
When Should Business Appraisers Dismiss GTM Entirely?
If the transaction databases relied upon lack the answers to the questions above, there may be insufficient data for an appraiser to accurately assess the comparability of the acquired guideline company in a transaction and the subject company being valued. If this is the case, appraisers should consider not relying upon the GTM method as a primary method or to reject the method entirely. However, there is another school of thought that the range of GTM multiples may still be used as a reasonableness check to corroborate the values derived using other methods. However, this latter position raises the question that if the data for a given transaction is insufficient for purposes of relying upon it to estimate value, then what benefit is gained by relying upon a range of transactions multiples with the same limitations?
In the end, as with other valuation approaches, the GTM requires the business appraiser to exercise proper professional judgment. However, parties reviewing the work of an appraiser (e.g. legal counsel) should be aware of issues inherent in the GTM in order to assess whether the use of the GTM by an appraiser as the primary support for a valuation or as a benchmark to corroborate the values derived using other approaches and methods is appropriate.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.