If you are like most business people, figuring out the value of a public company seems straightforward. There is plenty of up to the minute information on the company’s stock price. Public companies have a large number of investors who pay close attention to business performance and actively trade its shares of stock. This gives you instant verification of market value as shares are bought and sold by all kinds of investors.
Besides, public companies are obliged to publish their financial performance results and explain to the public what their prospects look like going forward. All this transparency and audited data helps investors get a pretty good idea of what a public company is worth.
Private company info is, well, private
The situation is more complicated with privately owned companies. For one thing, private companies are under no obligation to disclose their financial results or business strategy to the public. Indeed, most business owners consider such information privileged and keep it under close guard.
Financial reporting for private companies is not uniform
To compound the issue, private companies are not required to comply with financial reporting standards, such as GAAP. If you are relying on comparable company profitability measures in your valuation, you may be comparing apples with oranges.
No market evidence of private company value
Sales of stock in private companies also tend to fly under the public’s radar screen. Only a certain class of well-off, professional investors is qualified to buy stock in private companies. Such private placements are governed by a raft of laws that exclude the general public from private business investments.
So there’s general lack of knowledge about the values of private companies, whether those that sell or attract outside capital.
Private business sales are under reported
Business brokers tend to be very competitive and shy away from sharing private company selling prices with each other or the public. In addition, selling a private company is difficult, and its price depends on the particular buyer and seller. This is nothing like calling your securities broker to sell shares in a public company. Private business sale is a major project that takes a lot of preparation and time.
The result of all these complications is that the average business person has little idea what a given private company is worth. Market data is sparse and unreliable, business financials are kept secret, and business selling prices are highly variable.
Choose valuation methods that work for private companies
So what can you do to ensure your business valuation holds water? In short, use the tried and true methods for private company valuation. Business appraisers have learned through the years to spend time in preparing for private firm valuations, then selecting valuation methods that produce consistent, dependable results.
Adjust financial statements to reveal the company’s earning power
To overcome the difficulties with financial results reporting, you would do well to adjust the financial statements in order to reveal the economic potential of the company. Business appraisers refer to this critical step as normalization. This way, you can start from the figures that can be used in your business valuation calculations.
Three ways to value any business
Just as with the public companies, valuation of private firms relies on the methods under the asset, income and market approaches.
Asset methods, such as asset accumulation or the excess earnings, are well known. In addition to calculating the value of a private company, such methods help you allocate the purchase price in a business sale.
You should apply market comparisons with care. If reliable business sale or valuation data on private firms is lacking, consider using similar public companies. There are plenty of small public firms that resemble their private counterparts quite well. The advantage is that the financial and business sale data is readily available and subject to audits and stringent reporting rules.
To account for the uncertainty of private company values, you can apply discount for lack of marketability, or DLOM for short. The idea with this method is to use the reliable data and then adjust your results for the difference between the public and private firm values.
Income based valuation methods are the typical choice when valuing private firms. You can calculate the value of any company, public or private, by using the well known discounted cash flow method. In addition, the classical private company valuation methods are available, such as the multiple of discretionary earnings.
Choose several methods to get accurate valuation
Picking a few methods under each approach is an excellent idea as it helps you zoom in on key value drivers. Your business valuation would truly stand out if it shows solid thinking and attention to detail that the different methods provide.