Company valuation introduction

Whenever there is a discussion about funding a company or an entrepreneur and company financing, it always turns into a topic of company valuation. Assessing a company’s worth through its financial performance and market conditions is essential for determining fair market value and making strategic decisions. Company valuation is a complicated yet necessary process that provides insights into a business’s worth.

The Private Company Valuation Market was valued at USD 5,843.31 million in 2023 and is projected to reach USD 9,740.26 million by 2031 at a CAGR of 7.57% from 2024 to 2031.

Understanding company valuation is essential for business owners, as it influences decision-making. This article has been prepared with this requirement in mind.

What is a Company Valuation?

Company valuation is a process where the economic value of a company is determined. With the help of the valuation, you would be able to determine the fair value of a company. These include determining the sales value, establishing partner ownership and also closing deals. The owner of a company usually visits professional business valuators for getting an objective estimate of the business’ value.

Importance of knowing worth of your company

There are many reasons why a company valuation is important. This assessment is significant for business owners, investors, and stakeholders in various strategic decisions and financial planning. 

Understanding the importance of company valuation can lead to better decision-making and enhanced business outcomes.

Business Valuation Glossary: Key Definitions

To understand briefly about the various methods of valuation, the following terms should be kept in mind:

• Liquidation Value – This is the overall money that the business gets if the assets of the business were liquidated and the debts were paid off. This is also a method for the company valuation that is considered by some companies.
• Book Value – As shown on the balance sheet, the book value of the company is the value of the shareholders’ equity in the business. This value is calculated by subtracting the cumulative liabilities of the business from the total assets that it has.
• Discounted Cash Flow (DCF) Method – DCF method of valuation is based on the predictions of future cash flows of the company. These are then adjusted in a way that helps to determine the current market value of the company. The main focus of this method is that it also takes inflation into consideration when calculating the present value of the company.
• Earnings Multiplier – The earnings multiplier is a method of valuation that can be utilized to obtain an accurate image of the value of a business. This is because the profits of a company are a much more reliable indicator of its financial success as compared to the sales revenue of the company. This method of valuation adjusts the future profits against the cash flow that has the potential to be invested at the prevailing interest rate over time. In short, the current P/E ratio is adjusted for accounting the current interest rates.
• Times Revenue Method -This is one of the methods of valuation where the stream of revenues produced by the business over a specified period is applied to a multiplier. This multiplier is based on the economic and industry environment. For example, a tech company may have a value of three times the total revenue. On the other hand, a service firm might only be valued at 0.5 times the total revenue.
• Market Capitalization – Out of all the methods of valuation, this is the simplest method for company valuation. The process is simple, by multiplying the share price of the company by the total number of outstanding shares. Let us say for instance that Microsoft Inc. traded at $86.35 on January 3, 2018. And with a total of outstanding shares of 7.715 billion, the company’s value would be $ 86.35 x 7.715 billion = $ 666.19 billion. Even though these are some of the common methods of valuation, the list of the valuation methods used today is endless. Some other methods include the asset-based valuation, breakeven value, replacement value, and many more.

Reasons for Company Valuation

Obtaining an accurate company valuation is a very crucial aspect of an ongoing business strategy, and should be kept up to date with monthly accounting and annual valuations. Below shared are some of the main reasons why there is a need for company valuation.

Attracting Investments

For startups and growing businesses, knowing the company’s value is essential in attracting potential investors. Regular valuations can instill confidence in investors by showcasing the business’s worth and growth potential, thereby increasing the chances of securing funding.

For different stages of a business, there is always a different type of investor for it. For instance, if you are at the startup stage, you may need a startup angel investor. In the initial stages, you cannot show patented equipment or technology that has a quantifiable or logical value, nor can you show a historical P&L.

In case you are a mature business and you are entering the next stage of the funding cycle, the tangible parts of the business like the profitability trending, sales reports, market sizings, audits, financial instruments, and more will likely be used for the company valuation. At this point, the investor is more interested in making sure that the business, its value or the cash flow would be the best collateral against their investment (mostly when the owner is not going to change any time soon).

Bring in partners or to share equity

Doing deals is another place where the shareholders of a company have a subjective and emotional view of value. And the very first step is to determine the company value through the right methods of valuation. After that, it is essential to decide on how the shares would change the game – earning shares instead of salary, additional investment, and others is an entirely different venture.

This logic becomes complicated in a service business since there are less fixed assets and the value of the enterprise is subjective. Hence, for the valuation, you would need experienced consultants to help them figure out the company’s value.

Mostly, shareholders tend to have agreements done as to avoid the discussions that are uncomfortable. But after the value has been reached, it is the right time to have more heated discussions about negotiations before the deal is made with independent people representing the shareholders.

Preparing for a sale

At the moment a company is about to be sold, you would need all the financial documents. Ideally, that has been audited by the experts.

Investment bankers usually have their own methods of valuation, protocols, formulas and would pitch you regarding their plan to assist you with a sale. This plan would also include their rough estimate to determine the valuation. It is crucial to have advisors who can assist you with both the investment value and the fair market value of your company.

The Fair Market Value sale would have the ‘multiples’ on your profit and revenue or comparable of other similar companies sold. Moreover, your cash, assets and other objective figures would be calculated as well. In the area of investment, the value of the business is observed in association with the considered value or gain of the buyer from the acquisition.

The investors would want to understand why you need the amount and how exactly they would gain it back. Their return would be figured out only when they know the actual value of the company.

So, if you have the company valuation ready and it has reached the ears of an investor, it would help you get a lot of attention and open deals by a potential investor. In short, it is a benefit to always have an updated company value under your sleeve.

During Mergers/Acquisitions

Suppose a corporation expresses interest in buying your company, and you agree to the sale. In that case, you will need to present the recent company valuation you conducted to determine the actual worth of the business.

It is also important to show them how much the company has grown since it began, how many assets withholdings and how the company would continue to grow along with the actual market value.

You need to get the actual value because many large corporations usually try to get other businesses or merge with other companies with as little money as possible. When you know the company valuation, you can negotiate your way to get the actual worth in any selling or merging agreement.

After you learn about the value of the company, and if you are offered a value that is less than what your company’s worth is, reject the deal or you can volunteer to enter a negotiation agreement. This would eventually assist both the sides to come towards a comfortable arrangement.

Better Knowledge of Company Assets

It is important to get the actual value of the business since estimates are not only considered. There are a lot of benefits of company valuation, some of which include that the owner can easily get proper business insurance coverage, how much to sell the company for, and how long it might take to grow to an estimated value.

The company valuation would help the company produce profits and easily make the successful and right deals in the market.

Why should Every Company Have a Valuation?

Still now convinced that you need a company valuation done with any of the methods of valuation? Well, here is a checklist of reasons why it is better to know the value of your business.

If you don’t get the company valuation done, someone else would

Yes, that is right! And even though it seems like a relief that you would not have to waste your time on it, it may be a bad thing in the end. If you are looking for a loan from the bank or any investor, they have their own methods of valuation that they work on. They may conduct a valuation process and get the value of your business, but if you indulge to cross-check with it, you would not have any valuation done to check their numbers. And that is why it is important that you have it done yourself.

In the same way, if you want to leave or sell your business, the IRS would end up getting the company valuation done. And since the IRS takes taxes from a company’s revenue, their valuation would be higher than what you might get or otherwise.

You can question a potential buyer’s valuation

Again, the company valuation that you have done would have a different value as compared to an investor that is joining the company. Even though we expect the investor to come in with a lower value, it is not that simple. The reason why buyers or investors come with a lower value is since they believe that it would attract the seller to them during the due diligence period.

Or, it might also be provided in an expectation that a little of the company valuation would be recovered via the earn-out provisions in the agreement. All this might seem to be a bit cheap, but the best way of having a grip on the investors or buyer is by knowing the actual value of your company.

Your retirement depends on it

If you haven’t come across this point till now, it is important to know as well. Every business owner should have a retirement plan since you aren’t going to work forever. And if your business is your retirement plan and you have not done the company valuation, it is difficult to figure out the true value left over for your retirement.

Let us take for instance that you would hand over your company to someone else, and expect a return every month. Or you want to sell off your company at retirement. And in this case, your final value of the company is $3 million, but you only get it at $2 million. You may end up sacrificing your happiness and financial health due to poor negligence.

It’s useful in key person planning

Let us say that you have an important person who you want to share your success with. But this person is not a successor owner, and you still want to share some financial incentives with this person. With the help of the sales, profits and other annual measures of the business, you would get the actual growth of the company, and this would help you have the right idea about the future.

In case you get a company valuation done, you would have a baseline value to utilize in prolonged compensation arrangements, like stock appreciation rights (SAR) and phantom stock plans. In short, there is no possible way to measure the growth of your business if you do not know where you are starting.

You may get challenged in Court

Sadly, a lot of businesses have been caught off guard when a company valuation issue reaches the court. There was a case where the family business went all the way to the supreme court since the family objected over the correct valuation to buy out a sibling.

On the other hand, there was a case where a business owner had used a book value to buy out the other family members. The IRS ignored each of the valuations and utilized an earnings-based, higher company valuation. Like these, there are many cases in the court where the IRS end up securing a multi-million dollar penalty from many of them. Hence, you lose everything you worked so hard for.

How can Eqvista Help With company valuation?

Eqvista offers a comprehensive suite of tools and services that significantly enhance company valuation processes for startups and established businesses:

• Unlimited 409a valuations – The platform provides unlimited 409A valuations, which are important for determining the fair market value of a company’s shares, especially for compliance with IRS regulations. 
• Cap Table Management – A well-organized cap table is essential for accurate valuations as it reflects the company’s equity structure. Eqvista streamlines cap table management, allowing businesses to manage their equity effectively.
• Cost-Effective Solutions – Eqvista helps companies save on costs associated with hiring external valuation firms. This is beneficial for startups and SMEs looking to optimize their financial resources.
• Simplified Valuation Process* – With Eqvista’s valuation software, you can get a valuation report in minutes. After completing the questionnaire, the valuation will be conducted based on the answers you provided.

*Please note that the valuation software does not provide a full report, but a quick summary that will be beneficial for your company.

Ready to get your company valuation with Eqvista!

Understanding the value of a business through valuation provides many benefits to owners and the company itself. Conducting regular business valuations not only supports financial decisions but also helps the long-term strategic planning and growth, by protecting and enhancing the value of the business over time.

Eqvista supports company valuation by providing services which are essential for businesses looking to accurately assess their value and make informed financial decisions. Get Your Free Valuation Estimate Today! Discover how much your business is worth with a complimentary valuation estimate from Eqvista.