Valuing a private company | Bank of Silicon Valley



Valuing a private company before a sale, or as a precursor to raising debt or equity capital, is an inexact science. In fact, the lack of a commonly accepted standard approach often means that buyers and sellers of small businesses come to the negotiating table with very different estimates.

However, if you need to establish the value of your business, there are many approaches available to help you do this. Here is an overview of the most commonly used techniques.

Several sides of the same coin

The options for valuing a business range from surprisingly simple to incredibly complex. Determining the most appropriate method for valuing your business involves a process of trial and error, without losing sight of your end goal. For example, if you intend to apply for a bank loan, the appraisal method you select should meet the expectations of the loan officer. Alternatively, if you want to review your business out of curiosity, you can take the simpler approach of providing a “back of the envelope” rating. Here are some options:

1. A multiple of income

At the simplest end of the spectrum, you can calculate the value of your business by applying a multiple to its revenue. Keep in mind that the multiple varies by industry and the nature of the business. For example, an accounting firm may sell up to one times its revenue, while a dog-walking business may charge a price equal to 50% of its revenue.

2. Sales from other companies

Similar to one of the methods used to appraise real estate, this approach uses the sales of comparable businesses to determine value. However, it presents several challenges. Sales details for most private companies remain confidential. Additionally, while a business may at first appear to share similarities with your business, in reality it may bear little resemblance to your business, and therefore provide a poor comparison.

3. Asset-based valuations

This method has two options: valuing the business as a going concern or valuing it at its liquidation value. The first requires subtracting a company’s liabilities from its assets and adding an amount representing “goodwill”, which is the value of intangible assets, such as the company’s reputation, to arrive at its value as a as a business in operation. Alternatively, calculating liquidation value requires identifying the price at which the company’s assets could sell in the open market and then subtracting the company’s liabilities. This calculation produces the net amount that the company could realize from its liquidation.

4. Discounted cash flow

This approach to business valuation involves forecasting a business’s cash flows, usually over five years, as well as calculating the terminal value of the business, which is the value of the business as a as a business in operation. Since operating a business involves risk, the value of the business must reflect this uncertainty. Simply put, there is no guarantee of generating the cash flows included in the projection and completing the sale of the business in the future.

So, when valuing a private business, you need to apply a discount rate, expressed as a percentage, to the projected cash flows and the terminal value. The higher the discount rate, the greater the risk of gaining future cash flows, resulting in a lower present value and reduced valuation. Adding the discount cash flows and the terminal value produces the cash flow value of the business and the future value of the business itself in today’s dollars.

Know your worth

Whichever method you choose, keep in mind that if your business has recently had a tough time that impacted its financial performance, the value of the business would likely be lower than you expected. Therefore, before investing the time, effort and expense associated with the more complex methods, make sure that the company’s recent performance is representative of the health of the company and therefore its value.

And while some business owners rarely calculate the value of their business, doing so on an annual basis provides a kind of health check. For example, if the rating is dropping year over year, you may find that the root cause is an operational issue that requires your immediate attention. In fact, given the visibility it provides into the overall health of a business, even a business owner with less than 12 months of operating experience can benefit from an assessment.

Whether you plan to sell your business, raise debt or equity to fuel expansion, or simply want to determine its value for your own satisfaction, either on your own or with the help of an expert in valuation, you can quantify the value of your business. .

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