If you are valuing a privately owned business, the income-based valuation methods are probably high on your list of tools. To use these methods, such as the Discounted Cash Flow technique, you need to determine the discount and capitalization rates.

Income based business valuation methods and company size

If you take a look at the Build-Up formula for calculating the discount rate, you will notice that the company size risk premium is one element. For a public company this is determined based on its market capitalization. This, of course, requires that you know the company share price and the number of shares outstanding.

How to estimate the size of a privately owned business

Since the market share price is usually not available for a private business, you need a different way to determine its size. One approach is to come up with an estimate of the equity value of the company, then use this to look up the size risk premium for your discount and cap rate calculation.

You can use a number of market-based valuation multiples to do this. For example, use the gross revenue based valuation multiple and multiply the most recent annual business revenues to come up with the business enterprise value of the firm. Subtract total debt from this for a quick equity value estimate.

Now use this figure to look up the appropriate company size risk premium and calculate your discount rate. You can then determine the value of the business with a high level of accuracy and cross check your results against the market-based estimates you developed earlier.

Business Valuation using All Three Approaches

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