For both investors and entrepreneurs, it’s critical to understand what goes into a company valuation and how those numbers are calculated. Here, we will explore what company valuations mean in the context of the private market, what data goes into valuation analysis, and different methods that can be used to estimate a company’s valuation.

What is a company valuation?

Company valuation refers to the process of determining the financial value of a business. Company valuation can be estimated using metrics including (but not limited to) revenue, profits, losses, sales growth, and factors such as business risks or market opportunities. Company valuations are used to estimate the business’ intrinsic value and are used by both entrepreneurs and investors.

It is critical to understand that a company valuation is simply an estimate. That said, the valuation process can still help investors and entrepreneurs make more informed decisions.

What data goes into private company valuation?

Many data points can contribute to a company’s valuation, both qualitative and quantitative:

• The team – Teams that have a track record of success can increase a company’s value; however, this isn’t enough to carry the business, and it shouldn’t be the only card stacked in a company’s favor.
• Financial history – Historical financial data can help project future growth, revenues, profits, etc., and is crucial in helping determine company valuation.
• The market – The state of the market, in general, can have a serious impact on a company’s valuation. Under a thriving market, certain products or services may experience higher demand than they would under poor market conditions.
• Competitive advantage – The longer a company can maintain a compelling competitive advantage, the better. Having a competitive advantage can significantly boost overall valuation.
• Size– The bigger the company, often the bigger the revenue it’s able to bring in. Larger companies also tend to have an easier time securing resources and talent.
• Assets – Trademarks, intellectual property, customer data, etc., can all increase a business’ valuation. Though it can be difficult to put a dollar value on assets such as these, they can significantly impact overall valuation.

How to value a company

If you’re interested in learning more about valuing companies that are still pre-revenue, check out this past blog that breaks down different methods commonly used in the VC world. In this blog, we’ll focus on finding the value of post-revenue private companies (meaning they have started to generate revenue).

Three commonly used methods used to value a private, post-revenue company are:

1. Discounted cash flow (DCF) analysis method
2. Multiple analysis
3. Net book value method

DCF analysis method

This method is used to estimate the value of an investment based on its forecasted cash flows. In other words, it requires calculating future cash flow projections and discounting them back to the present. To use this method, you must have access to financial data, as the discount rate (or rate of return) is calculated using earnings, dividends, and operating cash flow.

The simplified formula for DCF analysis is:

DCF = CF₁ / (1 + r)¹ + CF₂ / (1 + r)² + …+ CF_n / (1 + r)ⁿ

Where:

DCF = discounted cash flow

CF_i = cash flow period

r = interest, or discount rate

n = time in years before the future cash flow occurs

For later-stage, more mature private companies, this method is relatively simple in that it just requires comparison to similar public companies. However, it can be difficult to find the financial data necessary to compare private companies.

This method isn’t ideal for younger, earlier-stage companies, as there may not be enough cash flow to use this calculation method.

Multiples analysis method

This valuation technique uses financial metrics from comparable companies to arrive at a valuation estimate. This entails calculating a multiple of the target company (a ratio that is calculated by dividing one financial metric by another) and comparing it to similar private companies. A multiple could be something like value/revenue.

To use this method:

1. Start by identifying comparable companies with similar businesses structures that operate in the same or similar space. You may choose to use publicly traded companies to compare to; however, public companies are larger and less risky, making them an imperfect comparator.
2. Determine their market value
3. Use standardized valuation multiples to compare.

The most challenging part of using this type of valuation method is finding the necessary (and up-to-date) data. Comparable companies may not have publicly available financial information, or the information that is public may be stale.

Net book value method

Using the net book value method can be useful in determining the valuation of a company with a significant amount of assets, both tangible and intangible. Tangible assets could be land, tools and equipment, office space, etc. Intangible assets could be customer relationship, intellectual property, or the brand itself.

Net book value can be calculated in the following way:

Net book value = original asset cost – accumulated depreciation

A drawback of this method is that it doesn’t consider the value of growth expectations, certain leadership, etc.; therefore, it can generate a lower valuation relative to the other methods mentioned here.

Takeaways

Valuing private companies isn’t an exact science, and there are many moving parts to consider. The difficulty in finding financial data for private companies can make this task especially challenging, and without it, it requires making many assumptions. As such, it’s important to take private company valuations with a grain of salt, and ideally, use a combination of methods listed here to arrive at a more measured estimate.

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.