Determining the value of a private business can be a highly subjective process. Although private companies don’t trade shares, they still need to value their shares for many reasons including everything from raising equity to settling a divorce. Without the open market to determine share prices, we have to use a number of different subjective techniques to estimate the value of a private firm. These are 5 common techniques. No one technique is accurate on its own; you will typically use about 3 of these at a time to make an educated judgment.

Net Assets

This is a very basic approach that looks at the market value of items on the balance sheet for find the fair market value of the net assets, which is considered then the value of the business. It can be costly and time consuming to find the market value of all the assets, so it’s usually only used in a takeover of the entire company. It doesn’t make sense to do it if the businesses value is not mainly in the assets.

Market Based

The market based approach is a highly subjective method that attempts to use information available from open markets to help estimate the price of the non-traded shares. It often looks at similar publicly traded companies and attempts to apply their metrics to the metrics of the private firm.

Capitalized Earnings

The capitalized earnings approach is almost always included in the valuation process. This approach uses the philosophy that a business is worth what it will earn. The concept involves taking normal earnings and dividing it by a cap rate (discount factor). The tricky parts are determining what normal earnings really are, what assets are really parts of the business, and especially choosing an appropriate discount rate, which varies depending on the amount of risk involved.

Cash Flow

The cash flow approach uses a cap rate (discount factor) to figure out the value of the company using cash flows. This can be done by finding an average cash flow and dividing it by the cap rate or by projecting yearly cash flows and discounting them using the cap rate to determine the present value of the cash flows. This could be used to get an idea of what a startup company may be worth.

Gross Revenue

The gross revenue method assumes everything is reflected in the last years gross sales. Some factor associated to the industry is multiplied by the gross sales to get the value of the business.

Tags: business valuation, valuation methods, value a business
Categories: Lesson, Bachelor of Commerce, Entrepreneurship, Business
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