The valuation of a private company that reveals the baseline value of the business is an insight for the owner who wants to advance their business with transferable value. The valuation of a company can be imperatively instrumental in determining the company’s ability to utilize capital, identify gaps, measure progress, and meet customer and investor expectations.
The business valuation or the startup valuation is not as factual or objective as it might look. In a valuation of a company, whether it is in a pre-seed stage or making high revenues, there are numerous factors taken into consideration, factors, including.
-Business model
– EBITDA size
– Profit margin
– Products
– Competitor performance
– Assets
– Management team’s strength & depth
– Total addressable market
– Team’s expertise
– Goodwill,
– Location, and more.
However, determining the fair value of the company is a complex task. In order to evaluate assets successfully, business leaders need to know when to take into account which factor of the valuation. As there are numerous methods for estimating the valuation, this article will outline the different ways for valuing a business and valuing a start-up that you can use for the valuation of a private company.
Difference between Start-up Valuation & Business Valuation
Start-up Valuation
More often than not, start-ups are at their pre-revenue state and do not have any hard facts, revenue figures, or substantial information to base their valuation on. In such cases, educated guesses and assumptions become the base of start-up valuation.
It is just likely that a start-up’s products have reached the market, so determining its valuation is difficult. Thus, different methods are invented to calculate a start-up’s value based on factors such as the stage of the company, management risks, manufacturing risks, innovation, quality of the product, governmental risks, etc.
Business Valuation
The established business model that makes a steady amount of revenue makes it easier to calculate the business valuation. To calculate the current worth of the business, analyze all the aspects of a business including assets, liabilities, taxes, capital structure, future earnings, depreciation, earnings before interest, and amortization (EBITDA).
5 Business Valuation Method
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The Book Value –
The easiest way to calculate the value of a company is by estimating the book value using the balance sheet information. The number calculated represents the value of the company’s tangible assets.
NOTE: Due to historical cost accounting and the principle of conservatism, balance sheet information cannot be equated to the value. Thus, this basic accounting matric does not portray a true business value.
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The Enterprise Value –
To calculate the value of an enterprise a company’s debts and equity are combined and subtracted by the cash not used in the business operation.
This means the formula to calculate the enterprise value is:
Enterprise Value = Equity + Debt – Cash
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The Discounted Cash Flows –
In, the Leading with Finance, the discount cash flows technique is marked as the gold standard of valuation. In order to analyze the business’ strength, profitability, and growth potential, calculating it is essential. Based on the discount rate and the time period of analysis, discounted cash flow analysis estimates the present value of future cash flows.
The formula for calculating Discounted Cash Flow is =
Terminal Cash Flow / (1 + Cost of Capital) # of Years in the Future
The challenge with this formula is that the valuation accuracy of this formula relies on the terminal value, which can vary with the changing assumptions about the discount rate and future growth. While the benefit is, it shows the company’s ability to develop liquid assets.
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Market Capitalization –
For the publicly-traded private company, market capitalization is the simplest method to place a value. The simplicity of this formula makes this formula doable in a fraction of a second. Multiplying the total number of shares with the current share price is the complete formula.
The formula looks like:
Market Capitalization = Share Price x Total Number of Shares.
Generally, the combination of debts and equity finance a company, but this formula will only account for the value of equity and not debt.
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The EBITDA –
EBITDA is the contraction of the term Earnings before Interest, Taxes, Depreciation, and Amortization.
To calculate EBITDA, subtract all the expenses from net income except interest, depreciation, taxes, and amortization.
To calculate EBITDA, start with getting the operating profit figure, also called earnings before interest and tax, and then add it to the depreciation and amortization.
There are two common formulas prevalent for calculating EBITDA. One formula uses operating income and the other one the net income.
Here are the formulas:
EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization
And
EBITDA = Operating Income + Depreciation & Amortization
5 Startup Valuation Method
Calculating the value of the startup requires your financial statements like a balance sheet and a bit of your guesswork. As this method uses several estimations, different startup valuation methods are invented to help start-ups calculate the valuation accurately.
The valuation of a private company takes into account numerous factors, including the team’s expertise, assets, product, goodwill, total addressable market, business model, competitor performance, market opportunity, and more. Let’s go through different valuation methods to determine the fairest valuation.
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The Berkus Method
American angel investor Dave Berkus created the Berkus Method to find the value of the companies that are in their early stage or at their pre-revenue stage. It assigns a range of values to the progress of a company whose owners have tried to take their start-ups off of the ground.
Founders and investors can avoid faulty valuations of the company with this simple formula based on projected revenue.
| If Exists | Add To Company Value |
| Sound Idea (Basic Value) | Up to $5,00,000 |
| Prototype (Reducing Technology Risk) | Up to $5,00,000 |
| Quality Management team (Reducing Execution Risk) | Up to $5,00,000 |
| Strategic Relationship (reducing Market Risk) | Up to $5,00,000 |
| Product Rollout or Sales (Reducing Product Risk) | Up to $5,00,000 |
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The Book Value Method
The book value method bases the tangible assets your company owns. In simple words, this is an asset-based evaluation to calculate the company’s net worth.
This method takes into account no revenue or growth. Organizations use this method specifically when a business is shutting down or when it is running out of business.
The formula for it is – the company’s total assets which are the book value of a company minus its liabilities.
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The Comparable Transactions Method
The comparable transaction method relies on precedent. We say this because a company uses this method to get an answer to – “what would a start-up like mine be acquired for?”
For instance, if the acquisition cost of a start-up is 9,000,000, and its website has 350,000 active users, it is roughly @25.71 per user.
So, if the start-up has 2, 00,000 users, it would multiply the users with the rate of @25.71 to reach the valuation of 5,142,000.
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The Cost-to-Duplicate Approach
The approach of Cost-to-Duplicate is to look at the hard assets of a start-up and replicate the value it would take to start the same new start-up. The idea of this approach is an investor would not invest more than that amount on the start-up to start a duplicate of the business.
In this method, you may calculate the patent cost, time taken, labor cost, research & development cost, and more. The disadvantage of this method is that it does not calculate any intangible assets like brand value, hotness of market, goodwill, reputation, and more. And that is where this cost-to-duplicate approach is said to be a lowball estimate of the company.
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The Discounted Cash Flow Method
This method involves working with the market analyst or an investor. In this method, you calculate the forecasted cash flow of a company and compare it with the expected return on investment (ROI) or discount rate.
So, the higher the discount rate, the riskier the investment, and the better your growth rate, the easier it is to get the investment.
The prediction works well when the ability of your team to analyze the market and make fairer assumptions about long-term growth is good.
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The Risk Factor Summation Method
The risk factor summation method is the pre-money valuation method. It uses the base value of a comparable start-up to calculate the valuation of your company.
It increases or decreases the company’s value in multiples, based on the twelve factors. For example, you can multiply the value by $250,000.
The twelve factors to consider are:
- Management
- Manufacturing risk
- Legislation/Political risk
- Funding/capital raising the risk
- Sales and marketing risk
- Competition risk
- Technology risk
- Stage of the business
- Reputation risk
- International risk
- Litigation risk
- Potential lucrative exit
So, when there are very low-risk elements or very positive signs of growth, you can add a double value, which is $500,000. However, when very high-risk elements are involved, deduct the value by $500,000. Besides the standard, positive and negative gains and risks can add $250,000 to the value. For neutral situations, there are no additions or deductions.
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The Scorecard Valuation Method
The scorecard method is another option available to calculate the value of the pre-money businesses other than the comparable transactions method. This method too involves comparing your business to other start-ups, but it has some added criteria.
After you have depicted the pre-money valuation of the private company, considering the following qualities, you will see if your business stacks up or down.
Strength of all teams: 0-30 percent
Size of opportunities: 0-25 percent
Sales channels, Marketing, and Partnerships: 0-10 percent
Products or services: 0-15 percent
Competitive environment: 0-10 percent
Need for additional investment: 0-5%
Other factors: 0-5 percent
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The Venture Capital Method
The venture capital method is again a method to calculate the pre-money start-up valuation.
This method offers two formulas to calculate the valuation.
- Anticipated Return on Investment (ROI) = Terminal Value (Harvest) ÷ Post-Money Valuation
- Post-Money Valuation = Terminal Value ÷ Anticipated ROI
NOTE – Terminal value or the Harvest is the anticipated selling price of the start-up in the future. We estimate it by using reasonable revenue expectations in the year of sale and estimating earnings.
Wrapping Up
If you need a valuation to justify it to your investor or for other reasons, you can trust the methods mentioned above.
However, even though we have mentioned ways, methods, and formulas to track the valuation of a private company, the accurate valuation needs expertise, experience, and rationality to make the calculation. This will need your team’s expertise, experience, and hustle or an invested accounting professional.
Are you a rising venture who needs a business valuation? Talk to us!
Wiley Financial is a full-service accounting firm with over 20 years. We have helped numerous small and large organizations with their bookkeeping, tax documentation, and reporting. Get in touch to let us take your accounting up a notch.
