Valuation is determining the value of a company. This is very difficult to do with a start-up because valuation is established in the marketplace amongst the competitors. Ultimately it comes down to the buyer and seller, so it is difficult to determine ahead of time what the worth is. “Everything is worth what its purchaser will pay for it.” Valuation is an estimate of the worth through financial analysis and subjective assessment including:
- Stage of the company
- Management team assessment (tangible & intangible)
- Reason the company is being sold
- Stage of the economy and other general macroeconomic factors
- Cash flow including past, present and projected
- Who is valuing the company?
- Is it a private or public company?
- The availability of capital?
- Is it a strategic or a financial buyer?
- Is the company being sold at an auction?
- Projected performance
The valuation is calculated through the present and projected cash flows. “Remember the starting point for calculating cash flow is net profit plus depreciation plus any other noncash item expenditures.” Different industries use different ways to calculate the estimated valuation, some are very complicated and some are as simple as a multiple of cash flow or a multiple of revenue method such as times three.
It is important to value your company so you can know what sale price would be acceptable, how much equity to give up for a partnership, and to know how much equity to give up for investor capital. This valuation should be determined at least once a year to keep up with the current status of the business.
Valuation is based on positive cash flow, so the value can be dependent on when the valuation is estimated and how the cash flow is during that time. Buyers base the cash flows on the past and present and not the projected future. The value of the company is based on the amount of debt the cash flow can handle for a 5-7 year loan. For example with 80% debt and 20% equity, 80% of the company’s cash flow is projected over the 5-7 years. The stage of the company also effects the value, the earlier the stage the less it’s worth. It is best to seek equity financing after development of the product. The reason for selling the company can also effect the value of the company. If the company is being sold because of personal or financial problems then it will be sold for a lot less than it would have without problems. Other reasons for selling that may decrease the value would include, illness or death of the owner or family member, or internal conflict among the owners. Owners don’t have to disclose that much about the real reasons for selling. But information is key for the buyer, it is best if they can find out as much as possible about why the company is being sold. When it comes to valuation the buyer and the seller should remember to take all the factors into consideration the would affect the value of the company.
Rogers, S., & Makonnen, R. (2014). Entrepreneurial finance: finance and business strategies for the serious entrepreneur. New York: McGraw-Hill Education.