The pros and cons of market-based business valuation

If you are thinking about buying or selling a business, you undoubtedly want either to pay a fair price or to receive one. Valuing a business, though, can be somewhat challenging. After all, there are many valuation methods, each of which may produce vastly different results.

Business owners and investors often use market-based valuation to determine the worth of a venture. With this valuation method, you calculate a business’s value by estimating what it would likely bring on the open market.

No need for a review of financial documentation

Before buying or selling a business, there is some due diligence you must perform. In the early stages, though, market-based valuation may give you an estimate of a venture’s worth without having to perform an in-depth review of the company’s finances. That is, you can simply look for recent sales of comparable businesses in the area.

Considerable room for error

Even if you are able to find comparable sales, market-based valuation often leaves considerable room for error. That is, you may not know whether buyers paid too much or too little for comparable businesses. With market-based valuation, you also probably cannot determine whether a specific business’s financial data affected the sale price.

A lack of available data

If the venture you are thinking about buying or selling has a unique business model or operates in a remote area, market-based valuation may not be an option. Specifically, you may find no comparable business sales or too few to form a reliable estimate.

While using market-based valuation early may make a great deal of sense, it may also lead you astray. Nevertheless, working with a financial professional may help you to overcome the drawbacks that often accompany market-based valuation.