Business Valuation Review Volume 40: Issue 3

This article presents the first detailed statistical analysis of the volatilities of various commonly encountered financial metrics used in contingent consideration (and earn-out) agreements. The valuation of contingent consideration using an option-based methodology and non-equity volatilities is becoming more common in business valuation. We provide clear evidence that the volatility of five financial metrics—revenue; earnings before interest, taxes, depreciation, and amortization (EBITDA); EBIT, net income, and total assets—is strongly, negatively related to firm size and profitability. However, contrary to common belief, the volatility of these metrics is not related to a firm's financial leverage. We also calculated the volatilities using four different methodologies that are employed in practice. Although no theory guides the selection of methodologies, based upon our work, we have found that the year-over-year growth rate, using a quarterly frequency, provides the most reasonable results.

This article explains why pre–initial public offering (IPO) studies are not a valid basis for determining marketability discounts. They are unsound in concept because the pre-IPO transactions and the subsequent IPO are priced at materially different dates and because the IPO price is not knowable at the earlier date. They are unsound in practice for several reasons, such as selectivity—the data include only companies that subsequently become publicly traded—and the fact that any pre-IPO discount includes not only a marketability discount but also a second discount for the risk that the IPO may not take place.

Purpose

Business valuation providers and users benefit from common understanding of terms with clearly established meanings and consistent application throughout the profession.

To this end the following societies and organizations have worked collaboratively to compile definitions for the terms included in this Glossary:

ASA—American Society of Appraisers
CBV Institute—Chartered Business Valuators Institute
RICS—Royal Institution of Chartered Surveyors
TAQEEM—Saudi Authority for Accredited Valuers

This Glossary updates the International Glossary of Business Valuation Terms originally published in 2001.

Scope

This Glossary was developed as part of ongoing efforts to harmonize definitions for terms used in business valuation. It is intended to be

From the Editor

Volatility of Financial Metrics: Important Data for Contingent Consideration Valuations

Why Pre-IPO Studies Are Unsound in Concept and in Practice

Shannon Pratt's Valuing a Business - Preserving a Legacy

Introduction

International Valuation Glossary—Business Valuation

Purpose

Scope

From the Chair

Volume 40, No. 3 — Complete Issue

From the Editor

Customer Concentration: Good, Bad, or Ugly?

From the Chair

Delaware Valuation Decisions, 2021 to 2024

Volume 44, No. 1 — Complete Issue