There are many motives for which private companies may be valued. These may include sale of prospective to another individual or private entity, sale of a partner's interest to another or sale to a publicly-traded firm. The motive could also be for legal reasons such as estate tax purposes.
It is worth noting that, all values are not equal. That is, an equity value of a company will be different to its enterprise value. These will also be different from it invested capital value.
Therefore, any valuation analysis should commence with the type of value that needs to be established. The value of a company which could be allocable to its equity investors is known as equity value.
This represents the value attributable to an investors ownership interests in a company. The enterprise value, on the other hand, is simply the company's invested capital less its cash. This removes the impact of how much cash and cash equivalents the company could be carrying in determining the value of its operations. The invested capital value takes into account the value of the company without regard to how it was financed.
Thus, it represents the total value of a company's equity as well as its interest-bearing debt. It is important to note that these different forms of values measures different components of a company’s capital structure, however, they are interrelated. Some approved scientific ways on how to value a private company are as follows;
The asset-based approach estimates the value of the company based on its net assets. Usually, assets and liabilities are adjusted from the book value to their fair value. Adjustments are usually made to the company's historical financial records to present the assets and liabilities to their respective market values. Some of the adjustments may include adjusting non-currents assets to their respective fair market values, adjusting for any unrecorded liabilities including potential legal judgments. This form of valuation is most appropriate when considering a company which continuously makes losses. It is also appropriate for valuing a holding company as well as a capital intensive company. Two main concerns of this valuation approach are that it is difficult to value intangible assets such as intellectual property rights and also the company's future earnings are completely ignored. In sum, it is generally easy to calculate, information is readily available and also it provides a minimum value of a company.
The market-based approach values a company by evaluating other similar company’s current valuation metrics and applying them. There are two methods under this approach namely guideline transaction method and guideline public company method. The former values a company based on pricing multiples which are derived from the sale of companies that have similar operations as the subject company. Steps involved in the valuation includes discovering the transactions involving the purchase of the proxy company, selecting the transactions which is similar to the company’s activities, thus, in the same industry and happened in similar economic conditions and applying these pricing multiples discovered. Concerning the guideline public company method, this approach values a company based on trading multiples which are derived from publicly listed companies with similar business attributes. In applying this method, the company identifies a proxy publicly listed companies and adjust their company multiples for differences
with size and risk. These adjusted pricing multiples are then applied to the company. Ideally, the listed companies discovered needs to be companies in the same industry as the subject company but when these are not available or does not exist, other similar characteristics such as markets serviced, risks and other relevant factors can be considered. Market efficiency ensures that the multiples of comparable companies serve as a reasonable indicator for the company provided those metrics are chosen wisely. Because no two companies are perfectly alike, this method always runs a risk of comparing apples to oranges.
The income-based approach estimates the values of a company based on its expected future cash flows. Two broad methods used are the capitalisation of the cash flow method and the discounted cash flow method. The capitalisation of cash method is applied to companies that are expected to have relatively stable margins and growth in the future by taking a single benefit stream and assuming this grows at a steady rate into perpetuity. However, the discounted cash flow method is more flexible as this allows for variations in the margins and growth rates as well as debt repayments and other things that will not remain stable in the future. This is the most thorough approach to valuing a company and it is based on the assumption that the value of the business is equal to the present value of its projected future cash flows including its terminal value. It is worth noting that these expected cash flows and the terminal value is discounted using an appropriate discount rate which encompasses specific risks to investing in the company. Even though this approach requires a subjective view of forecasting future performance, theoretically, it is the soundest method of projections and assumptions are accurate.
In conclusion, regardless of the approach used in valuing the company, it is important to make sure the company's performance is a clear representation of its health and worth.