Market perception is an expression of the collective opinion of people in the market. These people include individuals (e.g., consumers, investors, employees, and stakeholders) and enterprises (companies, government departments, investment companies, NGOs, charities, universities to name a few). In many cases, some people take on the role of opinion leaders or influencers, making statements on behalf of the population (legitimately or otherwise) about a product, service, brand, company, or industry. In many cases, there are professionals that have a role analysing and reporting on various aspects of the market, such as securities analysts and economists. This thought leadership can itself influence the perception of the market – it can be ‘talked up’ or ‘talked down.’
Here we consider the market perceptions about the market that can impact the valuation of small, closely-held businesses. This is important for two reasons in the business valuation context:
- To properly value a business, it is necessary to consider the economic milieu in which it operates.
- Market perception directly impacts the way buyers and sellers – the market – will view the potential of a business.
There should be a discussion in all business valuation reports covering the economic conditions (globally, nationally, and regionally) and industry/sector performance. These discussions are a reflection of the valuation analyst’s assessment of market perceptions.
Overall, market perception is driven by opinion and sentiment. There is no absolute ‘truth’ that we can depend on. Further, the market perception gets updated with new information constantly, so it is never static. In business valuation, we need to be careful to express the market perception as at the valuation date. Since we are typically reporting on historical market perceptions (i.e., as at a valuation date in the past), we need to ensure to only use information that was known – or reasonably able to have been known – as at that date.
Like other similar economic factors, the market perception is an aggregate view of the behaviours of the entire population of market participants. Individuals will hold a range of views. We rely on this aggregate ‘wisdom of the crowd’ to provide a sense of where the market is heading. And sometimes, the crowd can be wrong.
In the context of small business valuation, market perception influences various aspects that impact the company’s worth and potential for growth. The following discussion provides an overview of how market perception can affect small business valuation.
Market Conditions
We start with macroeconomic factors that impact the economy as a whole. This provides the overall context of the market perceptions. A typical analysis will start with the global economy and global events that can impact consumer and business spending. Wars, significant weather events, major market interventions in the large economies, and oil prices are typically considered, as well as ‘black swan’ events like COVID-19.
The global picture is then taken to country-level. Factors like interest rates, inflation, and consumer sentiment all shape market perception, and can be looked at from a global perspective as well as a national perspective. In some cases, we will want to drill down to the regional economy. For hyperlocal firms (like a dairy or cafe), what is happening in the neighbourhood can also be important. For a local shop, news that a large housing development is happening nearby may be an important factor in determining its value.
Favourable economic conditions overall may result in a more positive view of a business’s prospects, potentially leading to higher valuations.
Industry Trends
In addition to the economic considerations, analysis of industry trends and the company’s stance to those trends can be crucial. In this context, we are focusing on trends in technology and product. A small business that has successfully adopted a breakthrough technology considered critical for the future of the industry is likely to be perceived as more valuable.
If a business is seen as innovative, forward-thinking, and adaptable to changing market trends, it is likely to be valued more highly. Market perception of the business’s ability to innovate can influence its growth prospects.
Industry trends can have an impact at a global, national, and regional level. We need to consider impacts at all levels.
Growth Trends
Building a picture of the growth and growth potential of the market (and ultimately the subject firm) is essential in business valuation. In many cases, also understanding these trends in related industries can be important as well. If you are selling software to legal firms, the growth potential of the legal market is probably more important than the growth of the software industry.
Market perception of the industry’s growth potential and the subject business’s ability to capture that growth is essential. A small business operating in a perceived high-growth industry can often command a higher valuation.
Local Factors
In some cases, the local presence can drive perceived value, and therefore any locality factors that might impact the subject firm should be assessed. There may be facets of the catchment area, local economy, and demographics that have a bearing on the firm and the local market.
For small businesses with a local presence, the perception within the local community can be a significant factor. A positive community perception can translate into increased customer loyalty and support, which can boost the business’s valuation.
Competitive Rivalry and Positioning
Here, we consider the impact of market participants, both collectively and individually, on market perceptions. It is important to appreciate that the market as a whole will have a market perception, as well as each firm.
The Competitive Landscape
The market as a whole can be characterised in terms of the competitive landscape. For example, the market might be described as having a large number of independent providers. A common structure is a small number of major providers, with a large number of small competitors.
The degree of competitive rivalry is important to assess, covering aspects like the barriers to entry and exit, and the availability of reasonable substitutes. If you haven’t recognised a Five Forces analysis, you might like to brush up on Porter’s model.
Where available, understand market share. In many markets, the real data are not available, so we rely on market perception indicating likely share. A business perceived as having a strong position in the market may be valued more highly.
At the Individual Firm Level
Once we have a reasonable picture of the overall market, we can then zoom further into the individual subject firm. Here, we want to analyse the firm’s competitive positioning, and consider its competitive advantage. Factors like Brand, Reputation, and Customer Loyalty can have a huge impact on company value – and make up an important part of the way the firm is perceived in its market.
Understanding potential sources of competitive advantage for a firm is critical to business valuation. In particular, the way any competitive advantage is perceived by the market, should be captured. This can result in the firm being valued more highly.
When investigating a firm’s market perception, it is essential to consider the firm relative to its competitors. Company owners will always believe their firm is superlative. This is known as the Ugly Baby Syndrome (which I will discuss in a later article). You need to look outside the firm to get a real picture of its market perception. Where data are available, industry benchmarks can be used to analyse firm performance against the industry.
Investor Sentiment
Investors – in particular those with the potential to acquire in this sector – are an important influencer of market perception. Investor sentiment can drive demand. High demand from investors in a market can drive up the perceived value of all businesses in that space.
In some cases, this demand can be fueled by speculation and hype. Valuations of firms in a market can have a bubble. In many cases, this is not recognised during the build up, it is only seen after the burst.
Hype can apply at the market level or the individual firm level. A firm can be seen as a breakthrough, as ‘hot.’ This can lead to inflated valuations in the short-term.
Application
Market perception can seem nebulous and highly subjective. And it can be if not analysed adequately. In a business valuation, market sentiment needs to carefully characterised to be of value. Through this analysis, the valuation analyst will be able to add depth to the otherwise dispassionate numbers we see used in the various valuation methods. These factors cannot be simply scored on a standard checklist as most are unique to the firm at that time. Market perception is one of the key factors that numeric valuation models fail to address.
It should also be noted that in most cases, analysis of the market perception only occurs in a full business valuation. You will not see it in a business appraisal, for example.