Private Company Valuation

Valuation is not an exact science. The most important question when we analyze a company is how much cash can it generate after taxes over its life.

Most small businesses when sold are done so at less than two times cash flow because it’s hard to keep them open after transition. Once a business reaches a certain size (e.g. over $1 million in EBITA) the multiples go up, and can go way up for businesses that are market leaders or very unique.

For instance, a company with $4 million in EBITDA and multiples in the 4.5x – 5.5x range (i.e., enterprise value) has a valuation of $18,000,000 to $22,000,000. Of course, it only matters when you want to sell.

That said, there are five major ways to value a business.

– Comparables
– Discounted Cash Flow
– Breakup Valuation
– Intrinsic Valuation
– Equity Valuation

There are two types of comparables, trading and transaction based with both taking an industry specific look at comps. Trading comps use public companies in the same industry with similar products and services. The premise is that these companies share similar business and financial characteristics. Public companies are used because there is abundant and detailed financial and market data available to compare the companies.

Transaction comps compares a company to what was actually paid to purchase similar companies. The premise is quite sound: this is what the market determined the prices were for companies bought over the last two to three years that were of a similar size and in a similar business. The challenge is the purchase price and other relevant information are not disclosed for the majority of private company deals.

The Discounted Cash Flow (DCF) method projects the value based on future cash flows. The premise is that the value of the company is the result of future earnings, specifically free cash flow. These future cash flows are then discounted to adjust for time and risk. GuruFocus has a great tutorial about DCF.

Breakup Value is also known as net current asset value. This takes into account all the tangible assets (those that can be sold) minus all the liabilities on the books. This is usually used when the company doesn’t generate a consistent amount of cash, thus making it harder to value.

Intrinsic Valuation is a close twin to discounted cash flow, tying in future projected earnings with brand (if any) and book value. This represents a much more accurate picture, but is usually only used when being overly cautious about equity investments, generally in the public markets.

Equity Valuation is tied to private equity placements and what an investor or group of investors own versus what kind of money is put up. For example, last year around this time, Uber raised $3.5 billion for 5.1% of equity placing its value based on money raised at $68 billion. The company lost $708 million in 2016 in the first 3 months of 2017.

Again, the most important question when buying a business is how much money can be extracted out of the business during its life. If the ask is far lower than that estimate, it’s a buy. As a good rule of thumb, we look for the fastest capital payback, again based on intrinsic value. Of course, it’s better to be pessimistic about your value and optimistic about your future.

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