A Guide to the Different Types of Valuation Models for Private Companies

Industry
Corporate Development
Private Equity
Venture Capital
Last updated:
March 1, 2022

There are many different ways to determine the value of a company. And with so many types of company valuation models available, understanding the differences and when to use each one can be overwhelming — particularly when it comes to evaluating private companies.

That's why we're sharing what we know from helping M&A professionals take a data-driven approach to measuring bootstrapped company revenue growth and investment readiness. Read on for a break down of the most popular types of valuation models for private companies.

What Are Valuation Models?

Valuation models are used to determine the worth or fair value of a company. Analysts take dozens of factors into consideration depending on the valuation method used, including income statements, balance sheets, market conditions, business models, and management teams. Getting the most accurate estimate requires the use of several different types of valuation methods and analyses, each of which has its own strengths, weaknesses, and appropriate use cases.

However, it's important to keep in mind that company valuations aren't entirely scientific. As James Faulkner, managing director at London-based VC firm Vala Capital says, "There is still a huge amount of art involved because the financial model [for valuing the company] will depend entirely on subjective inputs: estimates for everything from the rate of sales growth to the company’s salary costs for the next five years.”

Why Are Valuation Models Important?

Getting as close to an accurate estimate of company value as possible is critical to both business owners as well as investors.

Business owners care about valuation when:

  • They want to issue options for future shares to employees or partners
  • They want to raise capital or debt
  • They want to measure growth and performance over time
  • They want to sell their business
  • They want to take their company public

Investors, such as private equity (PE) firms or investment banks, care about valuation when:

  • They're mapping markets and developing investment theses
  • They want to invest in or acquire a company
  • They want to sell or liquidate an investment
  • They want to create a market or industry report
  • They want to measure portfolio performance

Public vs. Private Company Valuation

It's much easier to determine the value of a public company than a private company. Unlike private businesses, public companies must adhere to strict accounting protocols and report out on their financials. Their price per share is publicly listed on the stock exchange, so determining the current market value of a public company is as simple as multiplying its share price by its number of outstanding shares.

What Is Intrinsic Valuation?

Many analysts also calculate the intrinsic value of public companies. This involves going beyond market value to include other intangible factors that may impact a company's true current and future worth, like patents and brand recognition. It uses fundamental analysis to look at both qualitative and quantitive factors. Intrinsic valuation is also called absolute valuation.

What Is Relative Valuation?

In contrast to absolute valuation, which looks at various factors related to a specific business, relative valuation attempts to determine the worth of a business based on where it stands compared to other companies in the same industry. While public companies may be evaluated using both absolute and relative methods, private companies may only be evaluated using relative methods, since there is little to no financial data publicly available to establish intrinsic value.

There are a number of different relative valuation vs. absolute valuation techniques.

Relative Valuation vs. Absolute Valuation Techniques

Company Valuation Diagram

Absolute Valuation Techniques

Discounted Cash Flow (DCF)

Absolute valuations leverage what's called discounted cash flow (DCF) analysis. The goal of DCF is to estimate the future cash flow of a given business to understand whether an investment will generate a positive return.

There are many subtypes of the DCF model, including:

  • Discounted dividend models
  • Discounted free cash flow models
  • Discounted residual income models
  • Discounted asset models

The below video offers a breakdown of the DCF formula and how it might be applied in a real-life investment scenario:

Relative Valuation Techniques

Comparable Company Analysis

Comparable company analysis (CCA) is the most common method used to valuate private companies. The first step is to establish a "peer group" of public companies in the same industry that share similar characteristics such as employee count, age, etc. Next, select a multiple, such as EBITDA, and calculate the average across these companies. This average is then assigned to the private company.

Estimated Discounted Cash Flow

The estimated discounted cash flow method uses the same formula as the above DCF absolute valuation technique. However, it relies on average measurements from the private company's peer group to assess its weighted average cost of capital (WACC).

Precedent Transactions

The precedent transactions method involves looking at how much companies in the same industry were sold or acquired for, and applies their average valuation multiples to the private company in question. It's important that these companies are as similar to the given private company possible, and that the transactions being analyzed are recent. This is sometimes referred to as the "market multiple" method.

Other Common Types of Valuation Methods for Private Companies

Cost to Duplicate

This method values a company based on what it would cost to build it all over again from scratch. While fairly straightforward to calculate, the cost to duplicate approach fails to consider intangible assets and future revenue potential, which are both key for private growing companies.

Valuation by Stage

This is a rough estimate technique often used by early-stage angel investors. It essentially assigns value ranges based on various company milestones, such as developing a market-ready product or cultivating a customer base.

Risk factor summation example

Risk Factor Summation Method

This is a risk-based valuation technique that assigns points and associated dollar values to 12 specific categories, including litigation risk, competitive risk, and reputation risk.

Private Company Data Signals

Because numbers around revenue and growth aren’t publicly available for non-transacted companies, investors must use other data points to identify peer groups and leverage relative valuation techniques. However, even this exercise can be a challenge. Dealmakers often spend countless hours scouring the internet for accurate bootstrapped company information.

Fortunately, the latest data service providers are making private company data readily available to investment teams. SourceScrub recommends dealmakers pay attention to 9 core data signals:

  1. Growth signals: employee count, etc.
  2. Web signals: Search engine rankings, website traffic, etc.
  3. People signals: Board members, executive teams, etc.
  4. Investor signals: Company financing, investors, etc.
  5. Conference signals: Planned exhibits, past attendance, etc.
  6. Industry recognition signals: Won awards, buyer guide inclusion, etc.
  7. Ownership signals: Ownership type, structure, etc.
  8. News and events signals: Media coverage, new hires, etc.
  9. Growth intent signals: Job postings, etc.

In addition to identifying relevant peer groups and informing traditional valuation methods, easy access to data points like these empowers firms to also develop proprietary models and projections around founder-owned company size, growth, and value.

Learn More About Private Company Valuation

There are many different types of company valuation methods. But determining the worth or fair value of a company is a mix of art and science. While both business owners and investors care about accurate company valuations, estimating the worth of a public company is a much more straightforward and transparent process compared to private companies.

Private company valuations depend largely on relative valuation techniques that compare a given private company to similar public companies in the same industry. But finding the right data to construct these peer groups, run traditional valuations, and generate other proprietary projections isn't easy.

That's why modern, new school dealmakers are turning to the latest data and technology to learn more about founder-owned businesses fast. This aids in thesis development, company valuation, and much more. For more on this topic, read our New School Manifesto.

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