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| Current financial reporting guidelines require a market participant perspective in determining fair value. The lack of market participant information can delay or cause the loss of audits, loans, transactions, and potentially an IPO. Ideally, all valuations prepared for financial reporting purposes would be based on observable prices for market participants in an ideal principal market. Rarely, however, is such market data available when performing valuations related to an acquisition or impairment testing. Instead, appraisers must rely on alternative valuation techniques incorporating both observable and unobservable inputs to estimate fair value. These techniques are more subjective, and are based on the assumptions that market participants would consider if pricing the same company or asset. Determining which technique(s) to employ or assumptions to use should consider the circumstances of the engagement and the perspective of a market participant.
Do the market participant guidelines imply the market approach is always more representative of fair value? As with many issues, it depends. When a subject company operates in a niche market, often there are no similar publicly traded companies which are representative of market participants. An alternative to the market approach is the income approach. The income approach can incorporate appropriate assumptions regarding capital structure, debt-free working capital requirements, profit margins and other factors to synthesize market participant valuation.
Reliance solely on the market approach may distort value to the extent guideline companies differ from the subject company in expected growth, profitability, size, and business model. Any adjustments to the concluded valuation multiples, whether mechanical or based on the appraiser’s judgment, represent unobservable inputs.
The ultimate weighting of the income and market approaches depends on the availability and comparability of public companies or transactions. The income approach represents a market participant perspective when the assumptions used to determine the present value of cash flows are the same assumptions a market participant would consider. Fair value measurements are more frequent and more scrutinized in financial reporting. Improper valuations stall audits, raising costs for everyone involved, and can potentially delay a bank loan, an IPO, or a transaction. Financial reporting valuations require a thorough understanding of the accounting regulations, the subject company (or asset), and the marketplace in which it transacts.
Click here for more information on fair value measurement.
Merger and Acquisition Market Data
Merger and acquisition transaction data during the year ended December 31, 2009 showed improvement in the last quarter. The overall median enterprise value to EBITDA multiple for the latest three month period increased from last month to 8.0x. In specific sectors, Energy and Information Technology continue to show increases in the median multiples paid while Healthcare multiples continue to fall.
Overall Transactions During Latest Twelve Months 
The Overall Transactions chart shows a dramatic increase in the total number of mergers and acquisitions during the last three months of 2009. The total number of mergers and acquisitions closed during the first three quarters of the year ranged from 5,689 to 5,958 per quarter. In the fourth quarter of 2009, the total number of closed transactions increased to 6,768. However, these levels remain well below historical periods such as the fourth quarter of 2007 when approximately 10,000 transactions closed. Based on a recent survey by the Association for Corporate Growth released in December, dealmakers expecting merger and acquisition activity increases over the next six months jumped from 56% six months ago to 82%.
The transactions include both public and private companies and are grouped into three month periods. For more information regarding the transaction screen, click here.
We assisted a privately held company in valuing their common stock leading up to a reverse merger with a public shell company. The terms of the reverse merger included significant earnouts which had a drastic effect on the capital structure and subsequently the common stock value. Adams Capital employed a Monte Carlo simulation to model 10,000 outcomes for the company's stock price and the impact of the price movements on the earnout payouts. The valuations allowed the company to properly price and expense employee stock options with minimal tax risk.
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For more information about Adams Capital please visit www.adamscapital.com
Adams Capital, Inc. is a national business valuation practice with clients in 50 states and more than 20 countries. We are recognized for our thoughtful approach to complex business valuation matters.
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