7+ Ways to Value a Private Company [Private Company Valuation]

A private company is a company that is not publicly traded on a stock exchange.

The vast majority of businesses in the United States and around the world are private companies.

  • Publicly traded companies are less than 1 percent of all US firms and about one-third of US employment in the non-farm business sector.
  • So more than 99 percent of US companies are private and represent about two-thirds of all US non-farm employment.

They all have valuations of some sort – i.e., a price where the owner of the business and a buyer might agree to transact.

So, how do you value a privately held company?

There are a few different methods that can be used to value a private company.

Let’s take a look.

Discounted cash flow (DCF)

The most common method is the discounted cash flow (DCF) method.

With this method, you start by estimating the future cash flows of the business and then discount them back to present value. This gives you an estimate of what the business is worth today.

There are two different ways to discount the cash flows: the weighted average cost of capital (WACC) method and the internal rate of return (IRR) method.

The WACC method is the more commonly used method. With this method, you discount the cash flows using the weighted average cost of capital of the business.

The IRR method is a slightly more complex method. With this method, you find the interest rate that makes the present value of the future cash flows equal to the current value of the business.

You can think of DCF as estimating the value of a business by looking at its future cash flows.

To do a DCF analysis, you need to make estimates of the future cash flows of the business. This can be difficult, especially for small businesses.

It is important to remember that DCF is a forward-looking analysis. This means that it is based on estimates of future cash flows. As such, it is subject to uncertainty and risks. Various assumptions must be made.

DCF is a useful tool, but it should not be the only tool you use to value a business. You should also consider other methods, which we cover below.

 

Discounted Cash Flow | DCF Model Step by Step Guide

 

Precedent Transactions (Market Approach)

Another common method is the market approach, or precedent transactions.

With this method, you look at similar businesses that have been sold recently and use those sale prices to estimate the value of the business you’re looking at.

This is often used in conjunction with the DCF method to get a more accurate picture of value.

To do a market approach analysis, you need to find businesses that are similar to the one you’re trying to value.

This can be difficult, especially if the business you’re looking at is unique.

You need to make sure that the businesses you’re using for comparison purposes are of a similar size, have comparable profitability and growth potential, and are in the same industry.

Once you’ve found some businesses that meet these criteria, you can start looking at recent sales data.

There are a few ways to do this:

You can look at public records of business sales

This is often difficult because not all business sales are public record.

You can look at recent transactions in the securities market

For example, if there was a recent IPO (Initial Public Offering) of a company in the same industry, you can use that data to estimate the value of the business you’re looking at.

You can ask an investment banker for recent transaction data

This is often the most accurate way to get data, but it can also be the most expensive.

The goal is to find a multiple that you can apply to the business you’re trying to value by looking at ratios between value and a performance metric, known as a multiple.

This multiple can be based on sales, earnings, or some other metric.

For fast-growing companies, earnings probably isn’t a great metric so sales would be better. For more mature companies, earnings or cash flow is probably more realistic.

Once you have a multiple, you apply it to the business you’re trying to value and that gives you an estimate of the business’s value.

For example, let’s say you’re looking at a business that had $10 million in sales last year.

You find three similar businesses that were sold recently and their sale prices were $50 million, $60 million, and $70 million.

After adjusting for differences in size, you come up with a multiple of 5.5x.

You apply that multiple to the business you’re looking at and get an estimated value of $55 million.

What to keep in mind when using precedent transactions analysis

There are a few things to keep in mind with this method.

First, it can be difficult to find comparable businesses. No two businesses are exactly the same. And businesses also change and evolve over time.

Second, even if you find comparable businesses, they may not have been sold recently, which makes it difficult to get accurate data.

Third, the multiple you use is based on recent transactions, so it may not be reflective of the long-term value of the business.

This method is best used in conjunction with other methods to get a more accurate picture of value.

It’s also important to keep in mind that this method is subjective.

The businesses you choose to use for comparison purposes and the multiple you apply will both have an effect on the estimated value you come up with.

If you’re not careful, you can easily overestimate or underestimate the value of a business using this method.

 

Precedent Transaction Analysis: The Full Guide and Excel Examples

 

Assuming a Constant Growth Rate (Gordon Growth Model – aka Dividend Discount Model (DDM))

This valuation technique tries to estimate what a business is worth today, based on its future cash flows.

It’s often used to value young companies that are growing quickly but haven’t yet reached profitability.

The Gordon Growth Model is named after Myron J. Gordon, who developed the model in 1956.

To use the Gordon Growth Model, you need to estimate a company’s future dividend payments and discount them back to the present day.

Gordon Growth Model Formula

The formula for the Gordon Growth Model is:

Value of Company = D1 / (r – g)

where:

  • D1 = next year’s expected dividend payment
  • r = required rate of return
  • g = constant growth rate of dividend payments

For example, let’s say that ABC Corp is expected to pay a dividend of $0.50 per share next year.

The company’s required rate of return is 10% and its dividend is expected to grow at a constant rate of 5% per year.

Based on this information, we can calculate that ABC Corp is worth $10 per share today:

Value of Company = D1 / (r – g)

= $0.50 / (0.10 – 0.05)

= $10.00 per share

As you can see, the Gordon Growth Model is quite simple to use.

However, there are a few limitations to keep in mind.

Gordon Growth Model Limitations

First, the model assumes that a company’s dividend payments will grow at a constant rate into perpetuity.

In reality, very few companies are able to maintain such steady growth indefinitely.

Second, the model relies on estimates for future dividend payments and discount rates, which can be difficult to make accurately.

And finally, the model does not take into account a company’s debt or equity structure, which can affect its value.

Despite these limitations, the Gordon Growth Model is still a useful tool for estimating the value of a company.

It’s particularly helpful for profitable companies that are growing at a stable rate, such that it fits the simplicity of the model well.

If you’re thinking about investing in such a company, be sure to keep these limitations in mind as you conduct your analysis.

 

Asset-Based Valuation Model (Liquidation Value)

Another common method is the asset-based approach.

With this method, you simply add up all of the assets on the balance sheet and subtract all of the liabilities.

This gives you the book value of the business, which may or may not be representative of its true market value.

To get a more accurate picture, you can also look at the net tangible assets, which is the book value minus intangible assets such as goodwill.

The asset-based valuation model has the advantage of being relatively simple to calculate and understand.

Asset-Based Valuation Model Limitations

However, it has several limitations. First, it only looks at the balance sheet and doesn’t take into account things like future earnings potential or competitive advantages.

Second, it doesn’t reflect the true market value of the business if its assets are worth more or less than their book values. Assets often have synergies that make businesses worth a lot more than their book value. Some businesses are not asset-intensive at all, which allows them to trade at high multiples.

So, based on this, this method only works for businesses that have a significant amount of physical assets; it’s not suitable for service businesses or companies with mostly intangible assets.

Despite its limitations, the asset-based valuation model can be a helpful tool for analyzing a business and understanding its value.

When used in conjunction with other methods, it can give you a more complete picture of the business and its potential worth.

 

Comparable Companies Analysis

Comparables companies analysis is a method of identifying similar companies in order to value a company using relative valuation.

Relative valuation is a process of valuing a company by comparing it to other companies that are similar in certain aspects.

The goal of this analysis is to find public companies that can be used as proxies for the company being valued. This method is often used in conjunction with discounted cash flow analysis and/or trading comps analysis.

How to Find Comparable Companies

There are several ways to find comparable companies.

One way is to use online databases such as Capital IQ or Bloomberg. Another way is to screen for companies with similar characteristics, such as size, industry, growth rate, etc.

Once you have identified a few comparable companies, you need to analyze them in order to select the best ones to use in your valuation.

There are a few key ratios that you should look at, such as price-to-earnings (P/E), price-to-sales (P/S), and price-to-book (P/B).

You can also look at other financial metrics, such as EV/EBITDA and enterprise value (EV) to sales.

Once you have selected the most comparable companies, you need to adjust for any differences.

For example, if Company A is much larger than Company B, you may want to use a lower multiple for Company A to reflect potentially lower growth.

You can also make adjustments for different growth rates. If Company A is growing much faster than Company B, you may want to use a higher multiple for Company A.

The key is to make sure that the companies you are using as comparables are as similar to the company you are valuing as possible.

Comps vs. Discounted Cash Flow Analysis

Comps is a lot more common in the business world while DCF is more common in the academic world.

But DCF is also commonly used among investment analysts as well.

The main difference between the two valuation methods is that DCF relies on future cash flows while comps relies on market prices.

DCF is a forward-looking valuation method while comps is a backward-looking valuation method.

This means that DCF is more useful when trying to value a company that doesn’t have any comparable companies.

Discounted cash flow analysis is also more useful when trying to value a company with high growth potential.

Comps are more useful when valuing companies in the same industry because it’s easier to find companies with similar characteristics.

It’s also easier to make adjustments for differences between the companies when using comps.

The main disadvantage of using comps is that it can be difficult to find truly comparable companies.

The other disadvantage is that comps only tells you what the market thinks a company is worth.

Discounted cash flow analysis is a more comprehensive valuation method, but it takes more time and effort to complete.

The main advantage of using DCF is that it doesn’t rely on market prices, so it can be used to value companies that don’t have any comparable companies.

 

Comparable Company Analysis (CCA) Tutorial

 

There are also a few main venture capital valuation methods.

First Chicago Valuation Method

The First Chicago Method combines different approaches and comes up with valuation-based probabilities of various scenarios working out.

It expresses valuation as a range, generally with three different scenarios:

  • base case
  • bull case
  • bear case

For each case, there is an associated probability that it will occur.

The first step in the First Chicago Method is to come up with these three different scenarios for the company being valued: base case, bull case, and bear case.

For each case, you need to come up with an estimated value for the company and an associated probability that it will occur.

Base Case

The base case is the most likely scenario. It’s not necessarily the best-case or worst-case scenario, but rather the one that you think is most likely to happen.

This is where you want to put most of your weight when coming up with a valuation.

Bull Case

The bull case is a best-case scenario. It’s a bit of a stretch, but it’s still possible.

You assign a lower probability to this scenario than you do the base case.

Bear Case

The bear case is a worst-case scenario. Again, it’s not impossible, but it’s less likely to happen than the base case or bull case. You assign the lowest probability to this scenario.

Once you have your three scenarios and associated probabilities, you can start coming up with a range for the company’s valuation.

This is done by taking the expected value for each case. The expected value is simply the valuation multiplied by the probability that it will occur.

Summing it up

You then take the sum of all three expected values to get a range for the company’s valuation.

For example, let’s say you’re valuing a company with the following three scenarios:

  • Base case: $1 billion valuation, 60% probability
  • Bull case: $2 billion valuation, 30% probability
  • Bear case: $500 million valuation, 10% probability

The expected value for each scenario would be:

  • Base case: $1 billion x 60% = $600 million
  • Bull case: $2 billion x 30% = $600 million
  • Bear case: $500 million x 10% = $50 million

And the sum of all three expected values would give you a valuation range of about $1.25 billion.

This is just one way to value a company using the First Chicago Method.

As you can see, it’s a bit different than some of the other methods we’ve looked at, but some DCF models will map out ranges as well by changing certain input variables, like growth or the discount rate.

It’s also worth noting that the Chicago valuation method is most often used when valuing early-stage companies that don’t have much in the way of financials to go off of.

 

Obscure Multiples Valuation Method

The obscure multiples valuation method is another common approach, particularly when a business has no financial history.

In such cases, you will need to logically think through how a business makes money and how that maps out to a reasonable market valuation.

Let’s say a company was building a web property based purely on informational content that it wanted to monetize with display ads.

It wanted to publish 10,000 articles and assumed that each article would get 200 views per month and would get ad revenue of $30 per 1,000 views.

That means it expects the 10,000 articles will eventually get 2 million views per month, which would net around $60,000 in ad revenue per month or $720,000 per year.

If almost all that revenue is profit, it would then apply a multiple based on what comparable businesses are selling.

If such a business sells at a 3x annual multiple, that would put its value at just over $2 million.

 

Venture Capital Valuation Method

The venture capital method works by imagining what the end result will be and then working back to a present valuation.

It’s basically like reverse engineering.

Let’s say a company has a chance to become a $1 billion valuation in time, but it will take 20 years. And you want 20 percent annualized returns over that time.

So the present valuation would be:

 

Present valuation = $1 billion / (1 + 0.2)^20 = $26.1 million

 

We can also check this plugging it back in:

 

Future valuation = $26 million * (1 + 0.2)^20 = $1 billion

 

So if one wanted to own 10 percent of the company, one might pay $2.6 million.

 

FAQs – Private Company Valuation

What is the Gordon Growth Model?

The model is used to estimate the present value of a stream of constant payments, typically dividends from stocks, where those payments are expected to grow at a constant rate into perpetuity.

The model is named after Myron J. Gordon, who made reference to it in his 1959 paper “Dividends, Earnings, and Stock Prices”.

What are the limitations of the Gordon Growth Model?

The Gordon Growth Model is a simplified way to value a stream of constant payments, where company dividend payments are expected to grow at a constant rate into the future.

Gordon Growth Model has a number of limitations:

  • It assumes that the payment stream (dividends) will continue forever. This is not realistic, as all companies eventually go out of business, merge with other companies, or get sold off.
  • It also assumes that the growth rate of the payments will remain constant forever. This is not realistic, as growth rates tend to fluctuate over time.
  • It doesn’t take into account the riskiness of the payments. This means that it doesn’t consider the fact that some payments may not be received at all (if the company goes bankrupt, for example).

Despite its limitations, the Gordon Growth Model is still a useful tool for estimating the present value of a stream of constant payments.

It is important to keep in mind its limitations when using the model, however, so that you don’t make unrealistic assumptions about the future growth of the company.

What are the most common company valuation methods?

There are many different methods for valuing a company, but the most common ones are the discounted cash flow (DCF) method and the comparable companies method.

The DCF method estimates the value of a company by discounting its future cash flows back to the present.

This is based on the assumption that investors are only willing to pay for future cash flows that are greater than what they could get by investing in a similar company with less risk.

The comparable companies method values a company by looking at similar public companies and comparing their market capitalization, earnings, and other financial metrics.

This is useful for valuing companies that don’t have a long history or haven’t yet been profitable.

Once you’ve selected a valuation method, you need to gather the necessary data and make sure that your assumptions are realistic.

After all, the value of a company is only as good as the assumptions that go into the valuation.

How do you value a private company with no comparable companies?

One way to value a private company with no comparable companies is to use the Gordon Growth Model.

The Gordon Growth Model is used to estimate the present value of a stream of constant payments.

Another way to value a private company with no comparable companies is to use the discounted cash flow (DCF) method.

The DCF method relies on estimating the future cash flows of a company and then discounting them back to the present.

This is based on the assumption that investors are only willing to pay for future cash flows that are greater than what they could get by investing in a similar company with less risk.

To use either of these valuation methods, you need to make some assumptions about the future growth of the company. These assumptions need to be realistic in order for the valuation to be accurate.

It can be difficult to value a private company with no comparable companies, but using a comprehensive valuation method like DCF can give you a more accurate estimate of the company’s value.

What is the most accurate valuation model?

The value of a business is the amount of cash it produces discounted back to the present.

Based on that, the DCF is the most accurate valuation model.

The DCF model takes into account the time value of money, which is the idea that a dollar today is worth more than a dollar tomorrow.

This is because you can invest that dollar today and earn interest on it.

The DCF model also takes into account the riskiness of the cash flows being produced. The higher the risk, the lower the present value of those cash flows.

So, in summary, the DCF model is the most accurate valuation model because it takes into account both the time value of money and the riskiness of cash flows.

 

Conclusion – Private Company Valuation

Valuing a private company is difficult, but there are some methods that can be used to estimate its value.

The Gordon Growth Model and the discounted cash flow (DCF) method are two common methods.

Both of these methods require making assumptions about the future growth of the company. Accordingly, it is important to make sure that those assumptions are realistic in order for the valuation to be accurate.

Precedent transactions and comps are other valuation methods, but can be difficult to find for a private company.

A comprehensive analysis using multiple valuation methods is the best way to value a private company. This will give you the most accurate estimate of the company’s worth. Then you can triangulate across various data points.

Private companies don’t have the same level of transparency as public companies, so it can be difficult to get accurate information about their finances.

By and large, the DCF is the most accurate way to get an accurate estimate of the company’s value. But it does rely on various assumptions.

Ultimately, it boils down to what someone is willing to pay.

 

 

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