Private Company Valuation Explained

Investors are increasingly interested in the future growth potential of private companies. As companies seek to acquire others for growth or strategic advantages, the demand for reliable valuation services increases significantly.

The Private Company Valuation Market was valued at approximately USD 5.84 billion in 2023 and is projected to reach USD 9.74 billion by 2031, growing at a compound annual growth rate (CAGR) of 7.57% from 2024 to 2031. Investments in enterprises depend on how much they are worth as a business.

A thorough company valuation is thereby essential for investors to see how much of the company their funds are worth. But, for private companies not traded on the market, it can get tricky and the methods vary with the format of operations.

What is private company valuation?

Private company valuation is the process by which a private company is assessed for its current worth. Though every company initially starts as a private firm before an IPO, there are broadly four categories of private companies in the United States:

• Sole proprietorship – Owned by an individual
• Partnerships – Owned by at least two individuals
• Limited Liability Company (LLC) – Owned by multiple people without the need for incorporation
• S Corporations – Ownership shared by a maximum of 100 people
• C Corporations – Unlimited ownership

Irrespective of its ownership model, a company requires funds for growth and expansion. Valuing a private company involves determining its economic worth through various methodologies, as there is no public market for its shares. This process is essential for various purposes, including transactions, compliance, and litigation.

Private company valuation reports that determine the estimated per-share value, i.e., the basis of equity financing. Investors evaluate funding proposals based on these reports. However, they provide only an estimate as a lot of the metrics are based on assumptions.

It is in the best interest of a private company to involve a professional business valuation firm to predict its best possible valuation and then compare it with another independent report from a contemporary firm.

Private Company Valuation Methods

Let us now look at some common valuation methods used for private companies. These methods look at different aspects of the company to determine its value.

Of the many that are available, the following three methods have proven to be most reliable:

Comparable Company Analysis (CCA)

This is the most commonly used private company valuation method.

Analysts begin by identifying definitive metrics of the target company. Meanwhile, a ‘peer’ group of companies sharing similar characteristics from the same industry are shortlisted. ‘Multiples’ are calculated for these peer groups of companies followed by the industry average. Private company valuation methods use various multiples depending on the industry and the growth stage. EBITDA is a commonly used multiple. EBITDA is an estimation of the company’s free cash flow and is usually predicted for 12 months. Thus,

Where by: Multiple (M) = Average of enterprise value / EBITDA of comparable firms

Let us take an example of the valuation of NewTech Inc., a growing software development firm, using the CCA method.

EBITDA (for the most recent fiscal year): $5 million

Determining the Multiple of Publicly traded companies in the software industry:

• Average EV / EBITDA Multiple = (5 + 10 + 6 + 4) / 4 = 6.25x
• Calculating the Value of TechSolutions Inc. (Target Company) = 6.25 × $5 million = $31.25 million

Thus, the estimated value of NewTech Inc. using the CCA method is $31.25 million.

Discounted Cash Flow (DCF)

This valuation method is based on the principle of estimating the target company’s future discounted cash flows. It is a step ahead of the CCA method and similar to it uses the financial metrics of the target peer enterprises in the public domain.

Analysts first calculate the average growth rates of shortlisted peer companies. This is followed by making projections of the target company’s revenues, taxes, expenses to generate its free cash flow (FCF). FCF estimation is usually done for the next 5 years.

The weighted average cost of capital (WACC) is a reliable discount rate used in these valuation methods. WACC gives a sense of the cumulative cost of capital inclusive of equity and debt.

Thus valuation of the target firm is: 

Let us take an example of NewProd Inc., a manufacturing firm using the DCF Method.

Free Cash Flow (FCF) for Next 5 Years:

• Discount Rate (r) = 12%
• Terminal Growth Rate = 3%

Calculating the Present Value of Future Cash Flows:

The estimated value of NewProd Inc. using the DCF method is $92.97 million.

First Chicago Method

This valuation method is a combination of the ‘multiples’ and DCF methods. It is commonly used by Angels and VCs as this method provides a fair idea of the best case as well as the worst-case scenario of a dynamically growing.

Let us take an example of the Healthcare Company, Healthify, Inc. using the First Chicago Method

Scenarios:

• Best Case (20% probability): Exit Multiple = 12x, EBITDA = $15M
• Base Case (60% probability): Exit Multiple = 8x, EBITDA = $10M
• Worst Case (20% probability): Exit Multiple = 4x, EBITDA = $5M

Calculating the Value for Each Scenario:

Assigning Probabilities and Calculate Weighted Values:

Calculating the Expected Value = 36 + 48 + 4 = $88 million

The estimated value of Healthify, Inc. using the First Chicago Method is $88 million.

What founders should consider for private company valuation?

For founders of private companies, understanding the valuation process is crucial for attracting investment, negotiating with stakeholders, and planning for future growth. Founders should familiarize themselves with various valuation methods, as each provides different insights.

Understanding of the key financial metrics are critical in determining a company’s value such as revenue growth, profitability and cash flow.

Founders must stay informed about industry trends that can impact valuations, such as market size and growth rates, competitive landscape, and regulatory factors.

The importance of intellectual property (IP), brand recognition, and customer relationships can enhance valuation by providing competitive advantages. Founders should prepare detailed financial models for their valuations when seeking funding that can strengthen negotiations with potential investors.

Identifying and addressing potential risks is important. Engaging professional appraisers can provide credibility to valuations: Professional insights help overcome complexities and ensure that valuations reflect the true economic status of the company.

Eqvista: Your Business Valuation Journey with Precision and Simplicity!

Private company valuations are based on their performance metrics as compared to similar companies in the market. Most of the analysis is based on estimates and future projections with industry benchmarks as reference.

Valuing a private company requires a nuanced approach considering various methodologies and external factors. Staying informed about trends and methods will be critical for accurate results as market conditions evolve. Eqvista prides itself on being one of the best and our expert team of analysts will guide you through your company’s 409a valuation. Also, our automated, sophisticated and user-friendly software makes it easy for entrepreneurs to manage cap tables, company shares and many more.