When it comes to determining the value of private companies, investors need to take a specific approach. This is because the process is not as transparent or as straightforward as assessing the value of public companies.
With a publicly-traded company, valuation can be determined by multiplying its stock price by its outstanding shares. However, as private companies do not publicly report their financials this means there is no stock listed on an exchange. That factor alone means it is often difficult to determine the market value of a private company that you may be interested in investing in.
However, certain variables and assumptions can be carried out to reach a private company valuation. Below we will look at some common ways to determine the market value of a private company and highlight other aspects that a potential investor should take into account.
Let’s get started with:
The Difference Between Public and Private Ownership?
A stand-out difference between companies that are privately held and those which are publicly traded comes with the fact that public firms have sold a percentage of the firm’s ownership during an IPO (Initial Public Offering).
It is an IPO that allows outside shareholders to purchase equity in the form of stock or to take a stake in the company. Once a company successfully goes through its IPO shares can then be bought and sold on the public stock market. These shares are then available to any investor wanting to buy them.
Conversely, private company ownership remains the domain of a select group of shareholders. Typically, these owners are company founders, key staff members, and initial investors such as angel investors or VCs (Venture Capitalists).
Because private companies do not have the same accounting standards as public companies they are not at liberty to publicly report their financials. Since there is no private stock listed on an exchange this means that would-be investors do not have access to detailed private company financial data. This often makes it difficult to determine the value of a private company.
Reasons for Valuing Private Companies
Because valuations are an integral part of business it is important to consider private company valuation from two sides of the coin.
For companies, their valuation is an important metric in helping them to measure the progress being made and the success thereof. It is also a valuable indicator for tracking their performance in whichever market sector they are in. That can be achieved through comparisons with competitor performance.
As for investors, they use valuations to help make decisions on the worth of any potential investments. Investors do this through the use of information and data made available by the company in question. Whether the valuation is for company or investor purposes it is essentially describing what a company is worth.
As mentioned at the beginning of the piece, due to the amount of data available from public companies it is far easier to understand their valuation than compared with a private company’s valuation.
We will shortly get into some established methods on how to assess the value of a private company. But first, let’s touch on the differences between public and private companies in terms of reporting requirements and how capital is raised.
Public companies are bound by set accounting and reporting standards. These are stipulated and strictly controlled by the financial governing body in the region they are registered in. This reporting includes a swathe of information such as various filings to shareholders along with quarterly and annual earnings reports.
Because private companies are not subjected to these stringent regulations it allows them to conduct business without these strict reporting requirements. This is a major reason why some private companies prefer to remain private.
This is where public companies have a big advantage. It gives them the leverage to tap public financial markets for capital. That is carried out by issuing public shares or corporate bonds. The access to a wider investment audience gives them the ability to raise funds should these public companies wish to expand their business or take on new projects.
As for private companies, there are times when they need to raise capital. This can be carried out in two main ways. First, they can give employees an opportunity to purchase stock as compensation. That is achieved by making a percentage of shares available for employee purchase at an agreed, favorable price.
Second, capital is raised through various staged funding rounds. When entering a funding round the private company will need to sell a part of the company ownership. This is achieved by securing investment from the likes of angel investors and venture capital firms.
Before this type of investor will consider investing in a private company they need to estimate its value. There are a variety of different ways for investors to go about valuing a private company. Here are some of the most common options:
CCA - Comparable Company Analysis
CCA is also called “trading comps'' and is the most common way for investors to estimate a private company’s value. This approach is where investors compare the current value of the private business with other similar publicly-traded companies.
During this process, research is carried out on companies in the same industry and where possible against a direct competitor. Other comparison criteria include companies of a similar age, size, and growth rate. It is usual for several similar companies in the same business sector to be identified for these comparisons.
Once this industry group has been decided upon, averages of their valuations or multiples are then calculated. This helps provide a sense of how the private company measures up within its business sector.
While different industries will have different metrics it is the P/E (Price/Earnings) comparisons that play a major part in valuation.
This is followed by:
Private Equity Valuation Metrics
Equity valuation metrics are then collected and collated. This includes P/E (Price to Earnings), price-to-sales, price-to-book, and price-to-free-cash flow. The EV/EBITDA (Enterprise Value to Earnings Before Interest, Taxes, Depreciation, and Amortization) multiple can be effective in helping would-be investors come up with a projected value.
This is why it is also known as the Enterprise Value Multiple because it provides a more accurate valuation through the inclusion of debt into its value calculation.
To calculate the enterprise multiple, the enterprise value of the company is divided by the company’s earnings before EBITDA.
Two common calculation formulas here are:
Enterprise Value of target firm = EV/EBITDA Multiple x EBITDA of the target firm
Equity Value of target firm = P/E Multiple x Net Income of the target firm
The EBITDA and/or Net Income that is used to value the target firm can be based on historical data known as LTM (Last Twelve Months) or a projected number.
Other valuation pointers occur if the target firm is operating in an industry that has seen such things as corporate mergers, recent acquisitions, or IPOs. Financial information from those transactions can be used to calculate a valuation.
It should be noted that no two firms are the same. However, consolidating and averaging the data from comparative analyses can prove to be effective. This is because it helps to determine how private companies in the same business sector as those who are already publicly trading are faring.
Estimating DCF (Discounted Cash Flow)
This is also referred to as the ‘income approach’. DCF valuation methodology relies more on similar companies in the peer group. Once this is calculated it is then applied to the target private company.
The first step here is to estimate the revenue growth of your target company. This is done by averaging the revenue growth rates of those companies in the peer group.
Estimating DCF in a private company can be challenging. Factors such as what stage the company is at and how accounting methods are calculated will affect the analysis. With regard to accounting, it has already been mentioned that private companies are not subjected to the same stringent accounting standards as public companies.
A private company may include such things as personal expenses, business expenses, and owner salaries that include the payment of dividends to ownership.
However, once revenue has been estimated it should give the ability to further estimate expected changes in the private company’s operating costs, taxes, and working capital. From there, free cash flow is calculated.
After capital expenditures have been deducted this provides the remaining operating cash. It is this free cash flow that investors typically use to determine how much returnable money is available to shareholders in the form of dividends.
Reduce Your Risk - Seek Professional, Insightful Assistance
Accurately valuing private companies is not an exact science. This means that any investor going through the process must be armed with as much information and insight as possible.
As described above, there are some established industry methods for valuing private companies. However, these calculations are based on industry averages, estimates, and assumptions. Due to the lack of transparency involved in private companies' finances, it can be a challenge to place reliable and accurate values on these businesses.
This makes it essential for would-be private company investors to gain maximum insight into the valuation processes available. They also need to leverage as much information as possible on the company concerned. To achieve this, professional advice and guidance should be sought.
WOWS Global is perfectly placed to offer the above and more. We are South-East Asia’s most active investor matching platform. Our state-of-the-art digital ecosystem has been tailored for smart startups and this leads to huge investor benefits through the ability to make highly informed investment decisions.
The highly experienced, professional team at WOWS fully understands that individual investors have individual needs. With that in mind, the exclusive private market investment opportunities available come from startups at all stages of their journey. This means investor-preferred matching is maximized.
Among the many strands of our services, approved investors have the ability to make informed decisions through access to standardized diligence material and ease of online access to financials. Our curated deal flow is also based on investor preferences and trends.
This means that whatever your private company investment preferences are, WOWS is ready to assist. To find out more, please contact WOWS for an initial, no-obligation chat on: