How to Value a Private Company – Step-by-Step Process

Valuing your private company?

It can be challenging due to a lack of financial data, which complicates the valuation process. You have to rely on estimates and projections, which can make it difficult to determine your business’s accurate value.

To ease the process, let’s discuss how to value your company, highlight the core business valuation methods, and identify factors that can impact your company’s valuation. 

We will also provide guidance on actions to avoid during the valuation process and outline scenarios in which valuations are beneficial.

Let’s begin.

TL;DR – How to Value a Private Company

The process of valuing your private company should follow these steps:

1. Gather data
2. Normalize financials
3. Clarify objectives
4. Choose the valuation methods
5. Determine the discount rate
6. Calculate the value
7. Compile results

For an in-depth look into how these steps work, read on.

Why Private Company Valuation is Uniquely Challenging

Valuing private companies is uniquely challenging due to the lack of readily available information for private companies. Consequently, valuers have to rely on formulas that provide specific, informed estimates. 

The primary valuation challenges include:

• Lack of a Private Market Price: Publicly traded companies have a value continuously listed on a stock market. This makes valuing them straightforward by multiplying the price by the number of company shares available. For a private company, you have to estimate valuations, so values are often presented as a range rather than a fixed figure.
• Challenges Valuing Intangible Assets: Private companies often derive most of their value from intangible assets such as brand reputation and intellectual property. Valuing such assets is challenging, unlike tangible assets such as buildings and machinery.
• Limited Ownership with Unique Control Dynamics: Private companies often have few owners, unlike public companies that may have thousands of shareholders. It creates a situation where the majority shareholders can demand a premium for their shares because they also control the company.
• Share Illiquidity: Selling or buying shares in private companies is difficult because they are not readily marketable. As a result, investors often demand higher returns to compensate for their inability to exit companies quickly.
• Limited Financial Information: Private companies are not required by law to publish detailed financial statements. Regulators also have less stringent reporting requirements for private companies. In addition, you cannot compare the values of private companies since the data is not publicly available.

Key Factors That Impact Private Company Valuations

The key factors that may impact your private company’s valuation are often financial, market-based, and internal dynamics. 

Below is a breakdown of the primary factors:

• Market Demand: If there is high, steady demand for your company’s products or services, it will significantly boost the company’s valuation.
• Market Share: If your business has a substantial share in the sector in which you operate, then you will benefit from factors like stability and economies of scale, which contribute to a higher valuation.
• Revenue and Profits: The primary drivers of your company’s value are consistent, predictable revenue growth and a healthy profit margin.
• Debt: If your company is highly leveraged, to finance operations and expansion, it can lower the company’s value due to the risk of debt repayment.
• Market Size: The size of the market your company operates in significantly impacts its growth potential, which, in turn, affects its valuation.
• Workforce Talent: Having a highly skilled management team overseeing your talented pool of employees can influence your company’s growth trajectory by leading effectively and improving productivity. 
• Intellectual Property: Having valuable intellectual property, such as patents and trademarks, and a recognizable brand can increase your company’s value.
• Valuation Method: Several methods are used to value private companies. Each methodology yields unique results, meaning your company’s value will fluctuate based on the method you use.
• Cash Flow: If your company has high and stable cash flow, your valuation estimates will be higher, as stable cash flow is an indicator of healthy revenue and profitability. It also means you have more cash at hand for expansion, debt repayment, and shareholder dividends.

Core Valuation Methods for Private Companies

The valuation process for private companies typically uses three approaches: the income-based, market-based, and asset-based approaches. 

Let’s look at some examples of valuation methods used in each approach:

• Discounted Cash Flows Method (DCF): This method is an income-based approach that estimates a company’s value based on its expected future cash flows. It uses a discount rate (typically the Weighted Average Cost of Capital or WACC) to account for the time value of money and risks associated with your investments. 
• Comparable Company Analysis (CCA): This method is a market-based approach that requires identifying publicly traded companies similar to your private company in terms of industry, size, and growth trajectory. It uses valuation multiples such as enterprise value-to-revenue, enterprise value-to-EBITDA, and price-to-earnings ratios derived from public companies and applies them to your company. 
• Precedent Transactions Method: This is another market-based approach method. In this case, valuation experts use the actual sale prices of recent M&A deals and multiples to determine the value of your company. 
• Adjusted Net Asset Method: This is an asset-based approach that focuses on a company’s current market value of assets and liabilities. It does not take future earnings into account. It requires adjusting all your assets and liabilities to their current values. Followed by subtracting the total liabilities from the total assets to obtain the net asset value.

How to Value a Private Company

Valuing a private company is not as straightforward as valuing a public company. It requires some preparation and crucial decision-making. 

Here is a step-by-step guide on how you should value your private company:

1. Gather Data

Have your finance department put together all pertinent financial information from the last 3-5 years. 

That includes financial statements, budgets, forecasts, and contracts. You should also include any recent interim financial statements that are yet to be formalized.

2. Normalize Financials

Normalization refers to adjusting historical financials to remove expenses that will not affect future performance. 

For example, nonrecurrent expenditure, such as a legal bill and adjustments to your compensation to market rates. 

3. Clarify Objectives

Clearly outline the valuation’s purposes with your CFO services provider. The purpose of the valuation affects the intensity and rigor of the process, discount rates, and transaction adjustments. 

Common reasons for valuation include divorce, sale, tax planning, and fundraising, for instance, through an IPO or bank loan.

4. Choose the Valuation Methods

There are different valuation methods for a private company. Each valuation method is appropriate for specific occasions. Therefore, your choice should be guided by what you want and the information available to you.

For example, the discounted cash flow method (DCF) works best when you have access to accurate forecasts and cash flows are your primary value driver. On the other hand, the comparable companies’ multiple approach is suitable when similar companies with publicly available data exist. However, you need to make careful adjustments for accuracy.

5. Determine the Discount Rate

The discount rate or WACC in the DCF approach helps determine the riskiness of future cash flows. Finding the appropriate rate for your company is crucial, since a lower rate will exaggerate the valuation, while a higher rate will downplay it. 

Calculate the required rate using publicly available market data, adjusted for size, liquidity, and company-specific risk.

6. Calculate the Value

Calculate your company’s value using the chosen approaches. The most common methods used are the DCF and market multiples approach. 

You can use other methods, such as the asset-based method, where applicable.

7. Compile Results

Compile the results from the different valuation methods you used. Then, determine a final figure or a range by weighting the methods used according to the relevance of the approach and reliability of the data. The valuation purpose should also be a factor in the weighting process. 

Understanding what drives the valuation of a private company is only one part of the process. The key challenge is in creating a systematic valuation process that captures the real value of the business you want to buy or sell.

At JS CPA Strategic Solutions, we have 10+ years of experience providing business valuation optimization, exit-readiness assessments, and fractional CFO services to founders and entrepreneurs looking to merge or acquire other companies.

Let’s help you plan your exit strategy, whether looking to sell your business today or in the next 3-5 years. Contact us today.

Common Valuation Mistakes to Avoid

Private company valuation is a challenging endeavor, often hampered by human errors. 

Below are some of the most common mistakes you might make during the valuation of your company: 

• Relying on Inaccurate Data: An accurate valuation of a private company requires using correct, up-to-date data. You cannot use old or unaudited financial information since it does not reflect your company’s real financial position.
• Over-Optimistic Projections: Private companies use future earnings potential to estimate valuation. However, you cannot be too optimistic when making such forecasts. You have to use historical evidence and consider market forces to make accurate projections.
• Poor Comparisons: The market approach valuation method requires the use of comparable companies or transactions in the calculations. However, many companies compare themselves to companies that do not align with them. For this approach to work, you have to find a company in the same industry as yours, of a similar size as yours, and with a comparable market penetration as yours.
• Ignoring Internal Risks: Most private companies ignore internal risks that may interfere with valuation. For example, a company may fail to consider the importance of key personnel, such as a founder, in the valuation. Therefore, you should audit all internal risks and how they can affect valuation. 
• Doing Your Own Valuation: Many private business owners try to value their companies by themselves, which often results in inaccurate figures. It is advisable to hire professional valuation services to help you pick the appropriate valuation method and conduct the data analysis.

When to Hire a Professional Valuation Expert

Knowing the actual value of your business can be essential to identifying areas of improvement and making necessary preparations for significant transactions. The right way to go about this process is to hire a professional valuation expert.

Situations where merger and acquisition advisory can be helpful include:

• Purchasing or Selling a Company: A valuation expert will ensure you do not overpay for a business during a purchase. Alternatively, they will help you accurately value your company during a sale to ensure you receive a fair price.
• Legal Purposes: An expert will help you navigate the valuation process when you need to overcome legal hurdles, such as splitting your assets with a spouse during a divorce or when estate planning. They can also offer guidance on tax compliance issues associated with the valuation process.
• Mergers and Acquisitions: A professional valuation expert will ensure the valuations presented by both parties during an M&A deal are accurate. It also helps ensure you do not leave money on the table or take on unnecessary financial risks to secure a deal.
• Business Planning: When planning for your company’s future, having an expert handle valuation will help you identify your company’s strengths, weaknesses, and risks, and allow you to make decisions that will bolster your company’s market position. 
• Seeking Financing: Banks and government agencies that provide financing, such as the Business Development Bank of Canada (BDC) and the Small Business Administration (SBA), often require business valuations to ensure a business can meet its loan obligations. 

Frequently Asked Questions (FAQs)

Here are some answers to common questions you might be interested in:

Is the Value of a Private Business Determined Solely by Its Equity?

No, the value of a private business is not entirely determined by its equity. 

Other factors, such as total assets and liabilities, market conditions, intangible assets such as intellectual property, and future earnings and cash flow potential, also influence a company’s valuation.

How Accurate are Private Company Valuations?

Private company valuations are less accurate than those of public companies. This is due to insufficient information, as private companies are not required by law to disclose detailed financial information publicly. 

Most valuation methods used to value private companies are estimates. 

How can a Business Owner Calculate Their Net Worth in a Privately Held Company?

To calculate the net worth of a business owner in a private company, you begin by estimating the company’s value using the valuation method of your choice. 

Then apply the business person’s ownership percentage. For example, if a business owner owns 70% of a private company worth $10 million, then their net worth is $7 million. 

How is a Private Company’s Value Assessed Before a Purchase?

A private company’s value is determined using several valuation methods. 

The most commonly used methods are the asset-based, market-based, and income-based approaches. 

Conclusion

As highlighted, private company valuation can be challenging due to an overreliance on estimates and multiples. However, combining multiple valuation methods and generating a weighted estimate is the closest you will get to an accurate valuation of your assets. 

You can navigate this challenging process with ease by finding the right valuation experts to guide you. 

JS CPA Strategic Solutions partners with experienced valuation professionals to guide you through the M&A process, including due diligence, risk management, deal structuring, and negotiation.

Don’t leave any money on the table when selling your private company. Book a no-obligation consultation today.