How to Value a Private Company
Knowing the value of your company is power. To apply for a business loan, assess the financial health of your company, anticipate a succession plan, or know when it's time to bring on more staff—you need a business valuation.
How to Value a Private Company: Getting Started
One of the greatest misconceptions we hear about getting a business valuation is that you only need one when you are ready to sell your business. This is simply not the case!
The world of valuations can be confusing for the average business owner, so it helps to know which valuation methods are relevant to your industry before you obtain one.
For starters, a non-publicly traded company uses different methods than a public company because it is not possible to determine company value by looking at stock prices or share value. It’s also important to understand how determining a company’s value is a subjective exercise. It’s part looking at the numbers, part industry philosophy of what makes a company worth a certain figure. While there are unpredictable elements to valuing a company, these best practices can guide you to a place of confidence in learning how to increase your company’s value.
Common Business Valuation Methods
Valuing a small business is not like valuing a Fortune 500 company. There are different resources available to measure value. Asset-based valuation, discounted cash flow, and comparable company analysis are a few examples. Choosing one formula and sticking to it tends to be the best approach, as each offers a slightly different take on valuation.
Here's a rundown on a few common types of valuations for private companies. The first is an income-based approach. It is called the “discounted cash flow method” or DCF for short. Discounted cash flow method puts a business’s cash flow through a series of calculations to determine future earnings. This is a good way to value a business that might be young or in high-growth mode but isn’t posting up big numbers for their profitability just yet. One potential pitfall with the discounted cash flow valuation is its margin for error. While current operating cash flow is easy to observe, variances that occur when the estimates are made for future purposes can result in inaccuracies.
A second valuation style used for private companies is asset-based valuations. Enterprises with large amounts of equipment or real estate use this method as it is a more accurate way to encompass what the business owns. Depreciation of assets is a big consideration for asset-based valuations because what something was worth 10 years ago isn’t valued the same today. To start with this kind of valuation, a list of equipment, property, inventory, and land is required to see where money is invested in the business currently, and how much it would be worth if the business liquidated its assets. While this is good for a business with a lot of tangible assets, grasping the value of intangibles may be tricker with this method.
The third kind of business valuation method used for private companies is comparable company analysis or market-based valuations. This looks at the current competitive space of your industry and notes how other businesses perform or sell of a similar size and profitability. This might work great for an emerging tech company that may not have a lot of time on the market but is acquired or sold at a high multiple for its demand or desirability. Startups, in particular, might use this method of valuation if they are in an industry that is high-growth and has more intangible assets than say a manufacturing company with its equipment and land assets.
Importance of an Accurate Private Company Valuation
Getting an accurate private company valuation is important for a few reasons. It helps you understand what your business is worth to a future buyer. It will help you know how much you qualify for a business loan. It will give you a window into your current and future cash flow standing which informs your business strategy. It also helps you visualize areas of improvement for your business. But it is important to remember that while there are ways of valuing private companies, because of the lack of financial transparency for private companies, it is less of an exact science. Many factors are under consideration and approaches for certain industries will not work the same as for others.
How to Calculate Company Valuation
Different firms offer a variety of services around how to calculate a company valuation. Some offer something high-level like a comparable company valuation (the simplest of the three methods we discussed) or a more deep-dive financial analysis of your company or industry that requires an accountant or financial analyst work. Comparable company valuations use industry averages to evaluate similar companies using metrics like operating margins and estimated cash flow. Asset-based valuations might require financial professionals or business analysts familiar with particular industries and the rates of depreciation on specific equipment. And lastly, discounted cash flow valuations focus largely on revenue growth. Revenue estimates can vary wildly depending on the cash flow projected for the future, and this is important to consider when undertaking a DCF valuation. Tax rates and depth-to-equity ratios are other metrics used to get a better understanding of a company’s DCF valuation.
Business Valuation Report
A business valuation report for someone who isn’t yet ready to sell their company might be important for understanding what drives up a company’s value. A business valuation report can reveal some important things about a business’s performance in the present and viability for the future. It is important with a business valuation to not just look at figures but also to consider the intangibles that make a business effective. This includes things like how differentiated your business is from its competitors, the extent to which your business can thrive without you as the owner, how easily you can sell more products to existing customers or acquire new ones, and how easily your business is disrupted by contingencies with suppliers or specific customers. Customer satisfaction and brand recognition are also intangible assets that can bring major value to your business if you invest in them.
Business Valuation Support with Coachwell
A business valuation report with Coachwell will cover all of these bases and more. Get keen financial insight into your company while looking at the full picture of how you are performing in your industry. Take the next step toward the future you desire, whether that includes the step to sell your business, or not. Get a private company valuation from one of our business growth consultants that is complimentary and yours to keep.
