A Complete Overview About: How to Value Private Companies

Dec 31, 2023 By Susan Kelly

Introduction

How to value private companies? Company and investor valuations are essential. Organizations can use valuations to measure their progress and market performance. Valuations can be used to determine the worth of possible investments. They make use of information and data that is available to the public from these corporations. What the company is currently worth in monetary terms. Valuing a publicly traded company is less complicated than privately held businesses. They are considering the wealth of information and data made available by publicly traded companies.

It is through a "valuation" that the worth of a privately held business is calculated. Companies trading on public exchanges can quickly achieve this by looking at their stock's price and volume in stock databases—the market capitalization of a publicly traded firm. Since private corporations do not have public stock prices, they cannot use this strategy. Since privately held companies are not required to comply with the same regulations as publicly traded companies, it can be more difficult to analyse their financial health based on their financial statements alone.

Methods Typically Used to Estimate the Worth of a Private Company

Critical Comparison to Competitors (CCA)

The CCA method is predicated on the hypothesis that companies in the same industry trade at similar multiples. When valuing a firm whose financials are not publicly available, we look for similar businesses and apply the multiples from those valuations to our target company. This is the approach of choice when valuing a private company. A "peer group" of comparable businesses is identified and formed to implement this strategy. These "peers" are chosen based on their shared characteristics with the target firm, such as size, industry, operation, etc. After tallying up the multiples of all relevant companies, we can calculate the average market multiple.

One of the most popular multiples is the earnings before interest, taxes, and amortisation (EBITDA) multiple, which we use as an example; however, the optimal multiple will vary depending on the industry and the maturity level of the company. EBITDA, or earnings before interest, taxes, depreciation, and amortisation, approximates a company's free cash flow. The value of the firm is calculated using the following formula: Multiplying the target company's EBITDA by the multiple yields the company's value (M). It is common to calculate a company's Multiple by dividing its Enterprise Value by its anticipated earnings before interest, taxes, depreciation, and amortisation (EBITDA) for the following fiscal year (M).

Using the Discounted Cash Flow (DCF) Model

Discounted Cash Flow (DCF) is an extension of the CCA method. The first stage of DCF is forecasting the company's long-term profit growth. As a result, we take an average of the expansion rates of comparable businesses. After that, we predict the target company's revenue, operational expenses, taxes, and so on for five years and use that information to calculate free cash flows (FCF). The formula for determining free cash flow is:

  • Free cash flow = operating income - tax rate - depreciation - amortisation - the difference in working capital (capital expenditure)

The WACC is the most acceptable discount rate to use for this company (weighted average cost of capital). It is possible to determine a firm's weighted average cost of capital by analysing its cost of equity, cost of debt, tax rate, and capital structure (WACC). When calculating the stock price, the Capital Asset Pricing Model (CAPM) is typically utilised (CAPM). The company's beta was determined by taking the sector beta and averaging the two. The rate of interest at which the target pays for borrowing money is a direct result of its creditworthiness.

One Chicago Approach

The First Chicago Method is a method for valuing a company that combines the advantages of multiples analysis with discounted cash flow. This novel strategy considers various potential outcomes for the target company's profitability. Using this method, you can prepare for multiple products, including the best case (which is what the company aims for in its business plan), the base case (which is the most likely event), and the worst case. Possibilities in each scenario are weighted differently. Using the Gordon Growth Model, we also make long-term projections for the company's value. After that, each case calculates a value using the DCF method. Finally, the target firm's value is determined by averaging the three possible outcomes, weighted by their relative probabilities.

Conclusion

Many assumptions, educated guesses, and averages are used to determine a private company's worth. Privately held companies have less available information, making it more challenging to assign an accurate value. The private equity sector and corporate finance advisory teams employ alternative approaches to company valuation.

Related articles
Method to Calculate the Gift Tax
Transfers of money or property to another person without receiving something of like value in return are subject to the federal gift tax..

Feb 20, 2024 Triston Martin

The Best Jobs That Don't Require a Background Check
Hey, we're not nosy. We could care less about why you don't want a potential employer to conduct a background check on you. Certain individuals would rather their prospective employers not do background checks on them. And it is completely acceptable to us. Because of this, we have compiled a helpful list of different positions for which it is possible that you will not be needed to have a background check done on you

Dec 09, 2023 Susan Kelly

Peerform Uncovered: A Comprehensive Review of Personal Loan Services
Explore Peerform's personal loan offerings, eligibility criteria, and borrowing experience in this comprehensive overview.

Feb 04, 2024 Susan Kelly

What Is A Mortgage Insurance Premium (MIP)
Learn what a Mortgage Insurance Premium (MIP) is and how it can affect your home loan costs. Get informed about how to protect your lender, understand the risks, and make an informed decision before taking out a mortgage.

Dec 11, 2023 Susan Kelly

All About Backup Withholding
Reserve withholding refers to money to cover potential tax liabilities associated with taxable investment withdrawals. The Internal Revenue Service employs backup withholding to guarantee the collection of taxes on investment income that may have been spent before the investor's tax payment is due.

Dec 03, 2023 Triston Martin

Furniture Store Credit Cards
You should remember that purchasing new furniture may be challenging, even though the prospect of doing so may excite you. The intriguing aspect is that even if you don't have enough cash to make the first buy, you may utilize one of the best store credit cards to make purchases from any furniture store, whether offline or online.

Nov 12, 2023 Triston Martin