Business Valuation: Definition, Methods and Examples

Determining the value of a publicly-traded company on a stock exchange is quite easy. It can be done by multiplying the share price by the number of outstanding shares. However, valuating a private company, especially a start-up, is not that easy. These companies do not report their financials publicly. Therefore, it is complicated and ambiguous to evaluate their true value.

Why is valuation important?

Valuating a Private Company and Start-ups is an important factor in the life of a company. It is helpful for the company and helpful to the investors. A valuation helps in measuring the progress and success of the company. Moreover, with the help of this valuation, the investors can also determine the approximate worth of their shares, which can help in potential investments. 

Methods of Company Valuation

There are certain methods through which the value of a private company can be determined. These methods are also helpful to valuate start-ups. Start-ups are in constant need of funds. They go through several rounds of investing before becoming profitable. These methods can help investors properly channelize their investments without the hassle of ambiguity and risk. 
Essentially, there are three methods through which Companies and Start-ups can be evaluated. 

Market-based Approach- This method entails matching a comparable firm (in the same industry, a similar business, and a similar market) with the company that needs a valuation. 
After matching the comparable firm, multiple suitable needs to be identified, which will be the factor that matches the two firms. The different multiples are:-

  • Price/Earnings-
    Under this method, the Profit obtained (after paying the tax) is multiplied to arrive at an estimate of equity value. This valuation is easy to understand. However, a drawback of this is that it is necessary for a comparable company to have a track record of profits. 
  • Price/Sales-
    Under this method, the share price is divided by the sales per share. This is a more coherent method than Price/Earnings since it does not necessarily need a consistent record of profits.
  • Price/Book Value-
    This method uses a multiple, which is applicable to the accounting value of net assets of the comparable company. This method entirely depends on the value of assets of the comparable company.
  • Enterprise Value/ Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA)-
    Under this method, the appropriate value in the numerator is taken as the Enterprise Value. A low ratio relative to other similar companies indicates that the company is undervalued, and a high ratio indicates that the company is overvalued.

Asset-Based Approach- This method involves calculating the total net asset value of the company. This is ascertained by subtracting total liabilities from total assets. This method is considered to be quite convenient since there is flexibility regarding the interpretation when it comes to making decisions on the assets and liabilities to consider in the calculation. 

Income-Based Approach- Under the income-based approach, the value of the company is calculated by using the Discounted Cash Flow (DCF). In simple terms, it calculates the present value of future cash flows of the company. This method helps forecast the amount of income the company is expected to derive or generate in the near future, this valuating the company.

With these different choices available, it is always prudent to first identify the available kind of data, calculate the data accurately, and consult an expert before taking any monetary steps. One of the most important rules to remember is that valuating private companies and start-ups are not easy and straightforward. It takes common sense, caution, and care to move forward with any complex valuation method.

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