A Guide to Common Private Company Valuation Methods

Introduction to Private Company Valuation Methods

Valuing a private company can feel a bit like trying to guess the price of a rare painting there’s no ticker symbol flashing on a screen to tell you what it’s worth. Yet, knowing a company’s value is critical for all sorts of reasons: attracting investors, negotiating a sale, or even just understanding what you’ve built as a business owner. Thankfully, there are tried-and-true methods to tackle this challenge. In this post, we’ll walk through three common approaches Asset Based, Discounted Cash Flow (DCF), and Market Value explaining how they work and tossing in some examples to bring them to life. Let’s dive in!

Key Considerations in Private Company Valuation

Key factors in valuing private companies include:

• Lack of Market Data: No stock prices to indicate market value.

• Financial Information: Less rigorous reporting standards complicate financial assessment.

• Ownership Structure: Affects valuation, especially with minority or controlling interests.

• Industry Comparisons: Relies on benchmarks that may not fit private firms.

Why Valuation Matters

Before we get into the nitty-gritty, let’s set the stage. Valuation isn’t just a number-crunching exercise; it’s the foundation for big decisions. Whether you’re an entrepreneur looking to sell your business, an investor eyeing a deal, or a company preparing for a merger, understanding value helps you navigate those moves with confidence. Private companies, unlike their public counterparts, don’t have a market price to lean on, so we turn to these methods to figure it out.

Common Valuation Methods

1. Asset Based Valuation Method

Think of this method as taking stock of everything a company owns and subtracting what it owes. It’s like assessing a house by adding up the value of its walls, roof, and furniture, then deducting the mortgage. The Asset Based method starts with the balance sheet, subtracting total liabilities from total net asset value to get a sense of worth. But there’s a catch it can be approached in two different ways depending on the company’s future.

Going Concern Approach

This approach assumes the company will keep running as usual. You value the assets based on their role in the business, not what they’d sell for in a yard sale. It’s all about what those assets are worth while they’re still in use.

Liquidation Value Approach

On the flip side, if the company is shutting down, you use the Liquidation Value approach. Here, you estimate what the assets would fetch if sold off quickly like a “going out of business” sale. Naturally, this tends to give a lower number since rushed sales rarely get top dollar.

Example: Picture a small furniture-making company. Its assets woodworking tools, inventory, and a workshop total $150,000, and it has $50,000 in debts. Using the Going Concern approach, the value is $150,000 - $50,000 = $100,000, reflecting the ongoing use of those tools. But if the company were liquidating, those assets might only fetch $90,000 in a quick sale, dropping the value to $90,000 - $50,000 = $40,000.

When to Use It: This method shines for companies with lots of tangible stuff like manufacturers or real estate firms. It’s less helpful for businesses where the value is tied up in ideas or relationships, like a consulting firm.

2. Discounted Cash Flow (DCF) Valuation Method

If the Asset Based method is about what a company has, DCF is about what it can earn. Often called the income approach, this method looks at the cash a business is expected to generate in the future and figures out what that’s worth today. It’s like valuing a rental property based on the rent it’ll bring in over the next decade, adjusted for the fact that money tomorrow isn’t as valuable as money today.

Here’s the gist: You project the company’s cash flows over a set period (say, 5 or 10 years), then “discount” them back to present value using a discount rate. That rate reflects risk and the time value of money higher risk, higher rate.

Example: Imagine a small software company that’s losing money now but expects to rake in $2 million in cash flow five years from now, thanks to a hot new product. Using a 12% discount rate (to account for the uncertainty), you’d calculate what that $2 million is worth today. The math gets technical, but roughly, it’s about $1.13 million way less than $2 million because of time and risk.

When to Use It: DCF is perfect for businesses with big growth potential or steady cash flows like tech startups or subscription services. It’s less useful if cash flows are erratic or hard to predict, and it’s sensitive to your assumptions. Tweak the growth rate or discount rate, and the value can swing wildly.

3. Market Value Valuation Method

This one’s like checking what similar houses in your neighborhood sold for to price your own. The Market Value method compares your company to others in the same industry, ideally using data from recent sales of similar private firms. When that’s tough to find (and it often is), some look at public companies’ market capitalization and adjust based on industry averages.

Example: Say you run a private coffee shop chain earning $300,000 a year. You hear that similar chains sold recently for 4 times their annual earnings. That pegs your value at 4 x $300,000 = $1.2 million. Or, if public coffee companies trade at 8 times earnings, you might estimate $2.4 million—but you’d adjust downward since your chain is smaller and riskier.

Caveat: This method assumes the “comparables” really match your business. Differences in growth rates, unique strengths, or intangible assets (like a killer brand) can throw it off. It’s a quick snapshot, not a deep dive.

When to Use It: Great when there’s solid data on similar companies or deals. Not so much for one-of-a-kind businesses with no clear peers.

Which Method Wins?

Spoiler: There’s no one-size-fits-all answer. Each method has its sweet spot:

• Asset Based is solid for asset-heavy firms but misses future potential.

• DCF captures growth but hinges on shaky forecasts.

• Market Value is fast and practical but can oversimplify.

In reality, pros often blend these methods for a fuller picture. A stable factory might lean on Asset Based with a dash of Market Value, while a startup might live or die by DCF.

Wrapping Up

Valuing a private company is part science, part gut feel. The Asset Based, DCF, and Market Value methods each offer a lens to see the business through—pick the one (or mix) that fits your situation. Whether you’re buying, selling, or just curious, these tools can help you crack the valuation code.