Private companies are those companies whose shares are not listed on public market. Since private companies aren’t publicly-traded, they are not required to publicly disclose their financials, making it quite challenging to perform a valuation.
What is Private Company Valuation?
Private company valuation is a method used to assess the current company’s net worth. Unlike public companies, where valuation is pretty straightforward, as we can simply pull out the stock price and the number of shares outstanding of the firm from the database, this method however, will not work for private companies.
Common Approaches for Private Company Valuation
Comparable Company Analysis (CCA) or Market Approach
The comparable company analysis uses the publicly-traded companies that best resembles the company being valued. It assumes that similar businesses in the same industry have common multiples. In this approach, we need to identify the characteristics in size, age, and growth rate of the company being valued to establish a “peer group” of companies with the same characteristics. We will then collect the multiples of these peer group and calculate their average to compare with the subject company. The most commonly used multiple is EBITDA multiple that can be used to calculate the value of private companies.
Present Value Approach
This approach assumes that the subject company’s cash value is equal to the present value it will generate in the future. In this method, we will start by determining the applicable revenue growth rate of the subject firm by calculating the comparable firms’ average growth rates. We shall also estimate the revenue growth, operating expense, taxes, etc., and generate free cash flows (FCF) of the subject firm. The next step is determining the average beta (a measure of market risk, disregarding debt), tax rates, and debt-to-equity (D/E) ratios of similar companies, and eventually, the weighted average cost of capital (WACC).
Cost Or Asset-Based Approach
The cost approach is based on the substitution principle —wary investors will not pay more for a replacement asset of equivalent benefit. Once we have allotted replacement costs for all assets, that cost is then adjusted by depreciation to get the current replacement value minus depreciation of the targeted firm. It is an excellent valuation method supported by current market costs and conditions.
Conclusion: Private company valuation is built from assumptions and estimate
Although private company valuation is quite challenging, the methods for calculating the value remains the same. Because information required estimating the value is a bit of a challenge, the principles for establishing value from each of the three approaches operate in the same way for valuing public companies. However, it is best to use more than one approach to ensure that your estimate of the value is reasonable and logical.
