How do you choose the best valuation method for a merger or acquisition?

Market approach has various drawbacks and only a diligent research on similar companies can give plausible results. The key similarities with the target company should be: Size, portfolio of services & products and business model, geography, clients and indebtedness. Plus: Instead of taking average of multiples, calculating the median is a better approach.

You will need access to databases for this - like CapIQ or Pitchbook. This is the quickest easiest way to get an objective opinion without room for much insult.

The income-based approach gauges a business's value by considering its income-generating capacity, focusing on factors like cash flow while disregarding the worth of the fixed assets. This method is most applicable to businesses with robust cash generation, particularly those not heavily reliant on assets. The Discounted Cash Flow method, a component of the income-based approach frequently employed in M&A transactions, calculates the present value of anticipated future cash flow. It is well-suited for businesses with projected consistent cash flow over an extended period.

While using the DCF method, I always run sensitivity analyses and want to see the changes in the underlying parameters such as discount rate, future sales growth & margins as well as the terminal growth rate.

The value would be different for the buyer and seller. The book value is usually less than the commercial value to both parties, unless this is a dying industry/liquidation.

Asset-based valuations are rather uncommon in pricing companies, especially in SMEs. Asset-based valuations often are considered as a valuation floor, as the incumbent instead of selling it in total, could also sell every component of the company individually. In asset-based industries such as raw materials or infrastructure asset-based valuations, of course, have its right to exist as the biggest part of the companies consist of those assets. Asset valuations tend to be more stable than valuations based on extrapolation of income or cashflow streams or multiples.

I am in more favour of the income approach. The value of anything (business, real estate etc.) is the expected cash flows to be generated. Naturally, the discount rate is quite decisive in this approach. However, there are several ways (diligent discount rate calculation, sensitivity analyses etc.) to overcome or at least to mitigate the risk of finding an unrealistic value.

The primary method would differ from industry to industry and type of prospective buyer. However, I think it is important to look it on a holistic view incorporating as many applicable valuation methodologies which helps reducing the bias. Only fundamental valuation likely be misleading as it would result in quite different valuations for all analysts / banks conducting the analysis (they would all have their different biases to Cash Flow drivers as well as pgr and discount rate). Relative valuation methods fail to capture unique characteristics of the target which might dictate higher multiples. Ultimately it is key to understand the affordability for a specific buyer considering how critical for them to acquire the asset.

It depends on the stage of the company and norms in the market. Early-stage companies will always be market-based whereas mature ones will probably be income based. It is handy to do both. Comps are very quick anyway.

The main valuation methods referred to are all "end results based ". I think that it is important to drill down and analyze separately the main drivers of those results including, but not only, to determine the comfort level of their sustainability that is being relied in determining a valuation that includes the given end result.

Valuation methodologies have limited use in most M&A processes. Income/market/asset FMVs are most often used to market assets to market on balance sheets, or for shareholder disputes, divorces, etc.. In M&A, buyers and sellers look to the EBITDA multiple ranges for their industry, apply size premiums, and submit offers reflective of the multiple range and attractiveness of the asset. When buyers are bidding on highly attractive assets, they have competition and generally will bid up the price if there's a strategic reason. If not, the LOI's offer will probably be the offer that sticks, which is on the lower end of the multiple range. It's frequently that simple in M&A.

Although valuations can provide a solid baseline or even a range of values for any business, one must also consideration the strategic value that would occur if two companies merged. For instance if one company has a significant customer base and the other company has a specific product that could be sold to that customer base, then there would be significant value that would not be reflected in any formal valuation method.

Make sure you have good access to data and databases. Rubbish in, rubbish out. Also hire a gun analyst to make sure its all perfect.