How to Calculate Value of Shares in a Private Company

Determining the value of shares in a private company is complex. Unlike public companies, private companies lack a transparent market for their shares, making direct valuation challenging. This process is often undertaken for mergers and acquisitions, estate planning, shareholder disputes, or securing financing. A thorough valuation helps stakeholders understand the true economic worth.

The valuation process analyzes internal company specifics and external market conditions to arrive at a defensible estimate. It combines financial analysis with an understanding of the business and its industry. Established methodologies allow for a reasoned and supportable conclusion regarding share value.

Key Elements Affecting Share Value

Private company share value is influenced by internal and external elements. Financial health is foundational, encompassing historical revenue growth, profitability, and consistent cash flow. Strong cash flows indicate a more valuable business, representing its ability to generate returns. Sustained revenue growth signals a positive trajectory and market acceptance.

Beyond financial performance, the industry significantly shapes valuation. Industry growth rates, competitive intensity, and barriers to entry can enhance or diminish a company’s prospects and value. The management team also plays a substantial role, as experienced leadership drives strategic initiatives and long-term success.

Intellectual property, including patents and trademarks, confers a competitive advantage and contributes significantly to intangible value. A strong brand and customer relationships further enhance this worth. External market conditions, such as interest rates, inflation, and economic outlook, influence investor sentiment and cost of capital, affecting the present value of future earnings. Regulatory environments and legal changes can also introduce risks or opportunities that impact value.

Common Approaches to Valuing Private Company Shares

Valuing private company shares typically involves asset-based, income-based, and market-based approaches. Each offers a distinct perspective on value and is suitable for specific business types. A comprehensive valuation often considers insights from multiple methods to arrive at a robust conclusion.

Asset-Based Valuation

The asset-based valuation approach focuses on the fair market value of a company’s underlying assets and liabilities. This method is particularly relevant for asset-heavy businesses, holding companies, or liquidation scenarios. It is also useful for companies with inconsistent earnings or those in early stages of development with significant tangible assets.

The primary method is the Adjusted Net Asset Method. It identifies all assets and liabilities on the balance sheet. The crucial step involves adjusting book values to current fair market values, rather than historical costs or depreciated values. Real estate and equipment may be revalued based on recent appraisals or market comparables, while inventory might be adjusted to its net realizable value.

Accounts receivable may be adjusted to reflect collectible amounts, and off-balance-sheet assets or unrecorded liabilities must also be included and valued. Fair market value is the price at which an asset could be sold, or a liability settled, in an orderly transaction. This ensures the valuation reflects current economic realities.

Once all assets and liabilities are adjusted to their fair market values, total adjusted liabilities are subtracted from total adjusted assets to arrive at the net asset value. This method is useful for companies with significant tangible assets, such as manufacturing firms or real estate holding companies. It is also commonly applied to distressed businesses or those with inconsistent earnings where income-based valuation methods might not accurately reflect underlying value.

Income-Based Valuation

The income-based valuation approach determines a company’s value based on its capacity to generate future economic benefits, typically cash flows or earnings. This approach is widely used for operating businesses with consistent profitability and predictable future performance. It rests on the principle that an investment’s value is derived from the present value of its expected future returns.

Discounted Cash Flow (DCF)

The Discounted Cash Flow (DCF) method projects a company’s future cash flows and discounts them back to their present value. This method involves several key steps. First, project the company’s free cash flows for a specific forecast period, typically five to ten years.

These projections should be based on historical performance, industry trends, and strategic plans. Free cash flow represents cash generated by the business after accounting for operating expenses and capital expenditures, available to all providers of capital. Forecasting involves projecting revenue, operating expenses, taxes, and changes in working capital and capital expenditures.

After projecting cash flows for the explicit forecast period, a terminal value is calculated to represent the business’s value beyond this period. This value can be estimated using either the perpetuity growth model or the exit multiple approach. The perpetuity growth model assumes free cash flows will grow at a constant, sustainable rate indefinitely, typically a low rate below long-term GDP growth. The exit multiple approach applies a market multiple (e.g., EV/EBITDA) from comparable companies to the company’s financial metric in the final forecast year.

Finally, all projected free cash flows and the terminal value are discounted back to the present day using an appropriate discount rate. This discount rate reflects the risk associated with the company’s cash flows and the time value of money. For private companies, the Weighted Average Cost of Capital (WACC) is often used, representing the average rate of return a company expects to pay to its investors. The sum of these present values yields the intrinsic value.

Earnings Multiples

Earnings multiples valuation applies a multiple derived from comparable public companies or recent private transactions to a private company’s financial metric. This method provides a market-based perspective, assuming similar businesses trade at similar valuations relative to their earnings. Common multiples include Price-to-Earnings (P/E), Enterprise Value-to-EBITDA (EV/EBITDA), and Price-to-Revenue.

To apply this method, identify comparable publicly traded companies. Comparability is assessed based on industry, size, growth, profitability, and business model. Data providers, industry reports, and M&A platforms are common sources for identifying comparables and gathering financial data.

Once a peer group is established, relevant financial metrics (e.g., net income, EBITDA, revenue) are gathered for both comparable and private companies. Multiples are calculated for comparable companies by dividing their market value (or enterprise value) by the chosen financial metric. For instance, an EV/EBITDA multiple is calculated by dividing a comparable company’s enterprise value by its EBITDA. These multiples are analyzed, often taking the median or average, to establish a range for the private company.

The selected multiple is then applied to the private company’s corresponding financial metric to arrive at its estimated value. For example, if the average EV/EBITDA multiple for comparable companies is 8.0x, and the private company’s EBITDA is $5 million, its enterprise value would be estimated at $40 million. Adjustments are important for differences between public and private companies, such as a discount for lack of marketability (private shares are less liquid) or a control premium (if for a controlling interest). This method is simpler and provides a market-based perspective, but finding truly comparable private companies can be challenging due to limited public data.

Market-Based Valuation

Market-based valuation relies on actual transactions or public market data of similar businesses to estimate value. This approach assumes the market provides the most objective measure of value for comparable assets. It is frequently used because it reflects current economic conditions and investor sentiment.

Comparable Company Analysis (CCA)

Comparable Company Analysis (CCA), also known as “comps,” values a private company by comparing its valuation multiples to those of similar publicly traded companies. This method is rooted in the principle that similar businesses should command similar valuations. The process begins with identifying a peer group of publicly traded companies that share characteristics with the private company, such as industry, size, growth rate, profitability, and geographic market.

Financial data for these public comparables, including market capitalization, enterprise value, revenue, EBITDA, and net income, are collected. From this data, various valuation multiples are calculated, such as Enterprise Value to Revenue (EV/Revenue), Enterprise Value to EBITDA (EV/EBITDA), and Price to Earnings (P/E). These multiples are then reviewed, and an appropriate range or median is determined. The private company’s corresponding financial metrics are then multiplied by these selected multiples to derive a preliminary valuation range.

For instance, if comparable public companies trade at an average EV/EBITDA multiple of 7x, and the private company has an EBITDA of $10 million, its estimated enterprise value would be $70 million. Adjustments are often necessary for differences between public and private companies, such as a discount for lack of marketability, reflecting the illiquidity of private shares. This method offers a market-driven valuation but depends heavily on the availability of truly comparable public companies.

Precedent Transactions

The Precedent Transactions method estimates a private company’s value by analyzing prices paid in recent acquisitions or sales of similar private or public companies. This approach provides a valuation based on actual market transactions, reflecting what buyers have recently been willing to pay for comparable businesses. The first step involves researching and identifying historical M&A transactions similar to the target company in terms of industry, size, geography, and date.

Data from these transactions, including the acquisition price and the target company’s financial metrics at the time of sale, are gathered. Valuation multiples, such as EV/Revenue or EV/EBITDA, are then calculated based on these historical transaction prices. For example, if a comparable company was acquired for $100 million and had $20 million in EBITDA, the transaction multiple would be 5x EV/EBITDA. A range of multiples is derived from several precedent transactions.

Finally, these historical multiples are applied to the private company’s financial metrics to estimate its value. For instance, if the median EV/EBITDA multiple from precedent transactions is 6.5x, and the private company has an EBITDA of $8 million, its estimated value would be $52 million. This method offers a strong indication of value because it uses actual transaction prices, but it can be challenging to find truly comparable transactions, and older transactions may not reflect current market conditions.

Information Needed for Valuation

Performing a comprehensive valuation requires gathering specific information and documentation. Key items include:
Historical financial statements (income statements, balance sheets, cash flow statements) for the past three to five years. These provide insight into past performance, financial position, and cash generation, crucial for trend analysis and forecasting.
Detailed financial projections, including revenue forecasts, operating expense budgets, and capital expenditure plans.
A well-articulated business plan, outlining strategy, market opportunities, competitive advantages, and management’s vision.
Resumes and organizational charts of the management team for assessing human capital.
Information on intellectual property (patents, trademarks) for understanding competitive moat and growth potential.
Copies of significant customer contracts, supplier agreements, and other legal documents for insight into business relationship stability.
Industry reports, market research data, and economic forecasts for understanding the broader market, competitive environment, and external factors impacting future performance and valuation.