How to Calculate Equity Value of a Private Company

Calculating the equity value of a private company is complex, unlike valuing publicly traded companies with readily available market prices. Understanding this value is important for business sales, attracting investment, succession planning, or determining tax liabilities. Equity value represents the worth of ownership interest after all liabilities. Since private companies lack a public market, valuation professionals use structured approaches to estimate their worth.

Income-Based Valuation

Income-based valuation methods assess a company’s worth by focusing on its ability to generate future income or cash flow. This approach is useful for businesses with predictable earnings and offers a forward-looking perspective. The Discounted Cash Flow (DCF) method is a widely used technique within this category.

The DCF method estimates a company’s value by projecting future cash flows and discounting them to present value. This accounts for the time value of money. Valuation projects free cash flows (FCF) over 5 to 10 years, using historical and future financial data. FCF represents cash generated by operations after capital expenditures.

Free cash flow is calculated by starting with operating cash flow and subtracting capital expenditures. Alternatively, it can be derived from net income by adding back non-cash expenses, adjusting for working capital changes, and subtracting capital expenditures. This FCF represents cash available to all capital providers before financing.

Projected free cash flows are discounted using a rate reflecting risk. The Weighted Average Cost of Capital (WACC) is used as the discount rate. WACC represents the average return a company expects to pay to all security holders, encompassing debt and equity, calculated by weighting the cost of each capital source by its proportion. The cost of equity can be estimated using models like the Capital Asset Pricing Model (CAPM). The cost of debt is the after-tax interest rate paid on borrowings, adjusted for tax deductibility.

Since cash flows cannot be projected indefinitely, a terminal value captures the company’s value beyond the explicit forecast period. This often accounts for a significant portion of the total DCF valuation. Two common methods are the Gordon Growth Model (assuming constant cash flow growth) and the exit multiple method (applying a valuation multiple to a projected financial metric). The terminal value is discounted back to the present using WACC.

The sum of present values of projected free cash flows and terminal value yields the company’s enterprise value. To arrive at equity value, adjustments are made for net debt and non-operating assets, isolating the value attributable to equity holders. Other income-based approaches include the capitalized earnings method, which values a business by dividing normalized earnings by a capitalization rate, suitable for stable companies.

Market-Based Valuation

Market-based valuation approaches determine a private company’s equity value by comparing it to similar businesses recently sold or valued. This method operates on the principle that comparable assets should command similar prices. The Multiples Approach is a primary technique, utilizing valuation multiples derived from comparable companies.

Valuation multiples express a company’s value relative to a financial metric. Common multiples include Enterprise Value (EV) to EBITDA, Price-to-Earnings (P/E), and Price-to-Sales (P/S). EV/EBITDA is often preferred as it is capital structure neutral and reflects operating performance.

A significant challenge is identifying truly comparable businesses, as private transaction data can be scarce and confidential. Professionals often rely on public company data due to its availability, but adjustments are necessary for differences between public and private entities. Public companies benefit from greater liquidity and access to capital markets, influencing their valuation.

Once comparable companies are identified and their multiples determined, these are applied to the private company’s financial metrics. For example, if comparable companies trade at an average EV/EBITDA multiple of 7x, and the private company has $1 million in EBITDA, its estimated enterprise value would be $7 million. This provides a market-derived estimate.

Required financial information includes the private company’s historical and projected financial statements, particularly earnings, sales, and EBITDA. Access to reliable data on comparable public companies or private transactions, including their financial metrics and values, is essential. Finding identical comparables is rare, and subjective judgment in selecting and adjusting multiples influences the outcome.

Asset-Based Valuation

Asset-based valuation methods determine a company’s equity value by totaling the fair market value of its assets and subtracting its liabilities. This approach calculates the net asset value, providing a baseline or liquidation value. It is relevant for asset-heavy businesses, such as real estate holding companies or manufacturing firms with substantial tangible assets.

This method is useful for companies facing financial distress or liquidation, shifting focus from future earning potential to existing assets. For service-based businesses with few tangible assets, this approach is less suitable. Valuing individual assets, such as property, plant, and equipment, may require independent appraisals to determine fair market value.

Intangible assets, such as patents or trademarks, can also be valued, though this often requires specialized expertise. Liabilities are generally valued at their current carrying amounts. The primary financial document needed is a detailed balance sheet, supplemented by appraisal reports for significant assets and information on any off-balance sheet or contingent liabilities.

A limitation is its inability to fully capture the value of unrecorded intangible assets like goodwill, brand recognition, or customer relationships. These assets can contribute significantly to an ongoing business’s value, which this method may overlook. It also does not account for the company’s future earning potential or its ability to generate cash flows.

Key Considerations for Private Company Valuations

Valuing private companies presents unique challenges compared to public companies due to distinguishing factors. These influence valuation methods and the final equity value. The absence of a liquid public market for shares is a significant factor.

Private company shares are not traded on public exchanges, making them less liquid. This leads to a “discount for lack of marketability” (DLOM), accounting for the reduced value of an investment that cannot be readily sold.

The size of the ownership stake also impacts valuation. A “control premium” may apply when valuing a controlling interest (over 50% of voting shares), reflecting the ability to influence management decisions and potentially sell the company. Conversely, a “minority discount” is often applied to minority interests (less than 50%). These adjustments reflect economic differences between controlling and non-controlling stakes.

Another challenge is obtaining reliable comparable data for private companies. Unlike public companies with transparent financial reporting, private company data is often scarce, confidential, and less standardized. This makes it difficult to find truly similar businesses, requiring greater reliance on professional judgment and broader ranges for multiples.

Many private companies, especially smaller ones, depend heavily on the owner or a few key individuals for success. This “owner dependence” poses a risk to profitability if the owner leaves or becomes incapacitated. Valuators assess management team depth and succession plans, as strong, independent management may command a higher valuation.

The quality of financial information can also differ. Private companies may not adhere to the same rigorous financial reporting standards as public companies. Adjustments are often necessary to normalize earnings for non-recurring expenses, owner’s perquisites, or inconsistent accounting practices. The future outlook for the company and its industry also influences valuation, considering market size, competitive landscape, and regulatory changes.