Unfortunately, there is no simple answer or formula that can precisely answer what a company is worth. The difficulty comes from two factors: predicting future revenues and valuing intangible assets or liabilities such as reputation/goodwill or value or a company brand. Nonetheless, this paper will go over the background, relevant variables, and examples of how to judge various companies. With this knowledge, evaluating company worth will be a more transparent and clear-cut process.
General Valuation Priorities
In any business, stakeholders like investors and owners/managers are very interested in evaluating company worth. They are all concerned in generating and maintaining the profit generators of a given business. A key concern is the value proposition: what do customers get for their money? Once a business identifies what exactly they want to give in exchange for enough money to generate a consistent profit, the next priorities arise:
- Acquiring physical assets, financing, and talent/skill necessary to make the business work
- Controlling costs during regular business operations without sacrificing quality
- Breaking into the market
A business can be judged by any or all of these metrics. Note that some valuation methods emphasize what a business currently has and owns, while other perspectives focus on what stream of income the business may generate in the foreseeable future.
Startup vs. Established Businesses
Established businesses can be contrasted with new startups by how they operate. Startups try to seize opportunity, develop a product, build a customer base and generate investor interest by any (legal) means necessary. New business employees will not be pigeonholed into one specific role; instead, they will be relied upon to generate value or cut costs across a swath of business operations ranging from the mundane to the managerial.
On the other hand, established businesses have jumped those hurdles. An established, measured set of processes will be far more important in guiding employee responsibilities, and customer expectations. Of course, not every facet of an established will be regulated. Creativity will continue to be valued but this can turn into loss of focus and product quality issues without standardized procedures that produce a consistent source of value or satisfaction for the customer.
Evaluating established business operation practices against many market peers is easier than judging the current and likely future value of a new business that has not yet determined what combination of freedom and process works best.
The unique dynamics of startups, combined with sporadic or even non-existent revenues, make traditional valuation metrics largely irrelevant. Nonetheless, there are a wide variety of startup valuation calculators that can be surprisingly effective in judging the effects of valuable assets, investor contribution, sales, multiple rounds of funding, and equity dilution.
Public Company Valuation
A public company can be the conceptual starting point for understanding more difficult-to-evaluate small private enterprises. First of all, we start with three basic valuation metrics: market cap, enterprise value (EV) and book value.
Market Cap is the simplest and most subjective, since it is the market-value of a publicly traded business at any point in time. Market cap can and does change on sentiment, fear, greed, panic, hope, and other emotions that has nothing to do with the fundamentals of a business’s liabilities, assets, or profitability.
Enterprise value is a measure of price that accounts for market cap with addition of debt and subtraction of cash. This may seem counter-intuitive to subtract an asset like cash, and add on debt, but the idea is to give an idea of total expenses for a buyer. Debt has to be repaid by any buyer, so additional debt would require additional expense to pay off. On the flip side, cash can be used to neutralize an expense, so it is subtracted from EV.
Book value is the price of assets minus liabilities, leaving a theoretical net value left to an owner if the business were to sell all its assets to satisfy all its liabilities.
These valuation metrics do not take into account current or likely future profitability, which is crucial in determining the future value of a business. For that, we turn to the discount cash flow model that treats a business in terms of investment ROI going forward instead of a sum of assets, liabilities, debts, and cash. There is wisdom in this approach since the sum of a company’s assets, liabilities, and market valuation do not speak to the desirability of the company’s products or services, nor to historic profitability trends that can mean the difference between riches and poverty to a committed investor.
Private Business Analysis
Private businesses are, in principle, no different than public corporations except that relevant financial information is more difficult to find. Whatever predictions about the future value of a business are generated should be back-tested if possible: would the method used to make predictions about the future have generated the present value and profitability of a business if enacted a few years in the past?
Investors may also perform what’s called a comparable company analysis; judging an easier-to-value public corporation with similar size, market, assets, and economic niche as the target private enterprise. If public corporations similar to a private business are struggling, it’s unlikely that the private business in question will be an exception.
Summary
Investors who delve into purchasing or investing in equity, especially private equity, should prepare for substantial risk and the chance of loss. This can seem scary, but keep in mind that every day people who don’t think of themselves as investors casually buy things like lottery tickets or exotic collectibles that have scant liquidity and/or a minuscule chance of payout. Diverting the money for such small purchases towards buying business equity can be surprisingly lucrative.
Company valuation can be complicated, but it is not meant to be prohibitive. This guide and others can be a good start to understanding and profiting from accurate evaluations of company worth.