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Private Company Valuation, Part 1: Are You in the Meth Business or the Money Business?
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Thanks for visiting! At the end of his long speech, Walter had inadvertently highlighted the three main types of private companies, proving that he understands the topic better than many finance students.
These examples and explanations are all taken from the private company valuation module in our Financial Modeling Fundamentals course. Would you value Ikeaa private company withemployees, and your local barber shopa private company with two employees, the same way?
Just as Walter White wanted to disrupt his competition from the Mexican drug cartels, these companies also plan to disrupt incumbents in multi-billion dollar markets. The goal is to build a management team, a Board of Directors, and a corporate structure that allows the company to go public or be acquired for hundreds of millions or billions of dollars.
These Empire Businesses are more like public companies because they have large and diverse management teams, Boards of Directors, and strong controls and processes. Unlike Money Businesses, these firms will not die if the owner or founder leaves; unlike Meth Businesses, these firms are profitable and could be public if they wanted to be. You also see valuation differences with Meth Businesses, but since the goal is to become a large, diversified corporation, the differences may not be quite as dramatic.
And you see the fewest differences with the Empire Businesses. Before you value any company, you need a correct version of its financial statements. For Meth Businesses and Empire Businesses, these points should check out because these companies should have proper controls and accounting systems in place. To illustrate, take a look at the fake Income Statement I created for this business click for a large version :. You still use the same valuation methodologies you use for public companies: comparable companies, precedent transactions, and the DCF.
There are some methodologies you cannot apply to private companies: one example is the premiums analysiswhich values a company based on the share-price premiums that buyers have paid for public sellers. But on the whole, the valuation differences lie in the mechanicsnot the methodologies. Comparable Company Analysis. You might use the same approach for Meth Businesses, but it depends on the purpose of the valuation as well. The buyer assumes a lot more risk by acquiring a private company, even a large and diversified one, and you have to account for that risk via lower multiples.
We still end up discounting the multiples in our BIWS valuation because the precedent transactions were all for massive companies that are not comparable. However, two problems emerge for private companies: estimating the discount rate and calculating the Terminal Value. The basic point is simple: the discount rate should be higher for a private company. Cargill employees have had issues with that one before!
But if the buyer is a single, non-diversified private conglomerate or an individual, the discount rate will be higher.
Think about it like this: is it riskier for you personally to buy a restaurant or retail store, or is it riskier for a large restaurant or retail chain to do so? Beta should be higher for less-diversified buyers and lower for companies in sectors that are closely correlated with the overall market. You might add a premium for true Money Businesses, a smaller premium for Meth Businesses, and likely no premium at all for Empire Businesses due to their size and diversification.
You could calculate TV with the Multiples Method or Perpetuity Growth Method and then cross-check it by calculating the implied multiple or long-term growth rate. The exact discount is highly discretionary and comes down to what your MD or Partner wants. This idea is simple: even if a business fails, its assets will still be worth something. You might assume that the company sells for Tangible Assets less Liabilities and then discount that value back and add it to the PV of the cash flows:.
Fred Wilson hits upon this point in an excellent blog post where he discusses how most entrepreneurs calculate ROI incorrectly : they assume their business will last forever.
The disadvantage is that now you have to estimate how many years it will take for that goblin-filled truck to kill the owner. The Bottom Line on Terminal Value: You calculate it in the standard way for Empire Businesses and Meth Businesses, but for Money Businesses you need to discount it heavily, skip it altogether, or make a more conservative estimate for it.
The result of all these valuation differences is simple: private companies should be worth less than public companies. There may not be a massive difference for huge private companies like Ikea, but there will still be some discount. You might have also seen news reports stating that tech startups are worth less after they go public.With time, the number of spreadsheets on this page has also increased.
To help you in finding the spreadsheet that you might want, I have categorized the spreadsheets into the following groups:. These spreadsheet programs are in Excel and are not copy protected. Download them and feel free to modify them to your own specifications.
I do have video guides available for some of the most accessed spreadsheets. I hope they are useful. One more point. I am not an expert on Microsoft Excel and am frankly mystified by some of the quirky differences between the Mac version which I use and the PC version which you probably have. If you want to refine your spreadsheet skills, you can of course by a book on Excel. However, a reader of this website, Alex Palfi of Tykoh Training, has been kind enough to offer this guide to using and building spreadsheets.
Please feel free to download it and use it and to then convey your appreciation to him. Regression Analyzer Webcast This spreadsheet allows you to check your computations of Jensen's alpha, range on beta and expected return, given the output from a return regression risk. Convert operating leases to debt Webcast This spreadsheet allows you to convert lease commitments to debt.
Optimum Capital Structure Cost of capital approach. To help you in finding the spreadsheet that you might want, I have categorized the spreadsheets into the following groups: Corporate finance spreadsheets : These spreadsheets are most useful if you are interested in conventional corporate financial analysis. It includes spreadsheets to analyze a project's cashflows and viability, a company's risk profile, its optimal capital structure and debt type, andwhether it is paying out what it can afford to in dividends.
These programs are broadly categorized into those that Estimate risk in an investment and its hurdle rate, as well as assess investment returns net present value, internal rate of return, accounting return Evaluate the right mix of debt and equity in a business and the right type of debt for a firm Examine how much a firm should return to investors and in what form dividends versus buybacks Valuation Inputs Spreadsheets : In this section, you will find spreadsheets that allow you to Estimate the right discount rate to use for your firm, starting with the risk premium in your cost of equity and concluding with the cost of capital for your firm.
Big-picture valuation spreadsheets : If you are looking for one spreadsheet to help you in valuing a company, I would recommend one of these 'ginzu' spreadsheets. While they require a large number of inputs, they are flexible enough to allow you to value just about any company.
If you have no idea which one will work for you, I would suggest that you try the "right model" spreadsheet first. Focused valuation spreadsheets : If you have a clear choice in terms of models - stable growth dividend discount, 2-stage FCFE etc.
Valuation of specific types of companies: Valuation is all about exceptions, and these spreadsheets are designed to help value specific types of companies including: Financial Service firms : While dividend discount models tend to be the weapon of choice for many, you will find an excess equity return model here. Troubled firms : You will find an earnings normalizer spreadsheet, a generic valuation model for valuing a firm as a going concern and a spreadsheet that allows you to estimate the probability that a troubled firm will not survive.
Private companies : You will find spreadsheets for adjusting discount rates and estimating illiquidity discounts for private companies. Young and high-growth firms : You will find a revenue growth estimator as well as a generic valuation model for high growth firms in this section.
Multiples : You can estimate equity as well as firm value multiples, based upon fundamentals. Valuation in Acquisitions : You can value synergy in an acquiisition and analyze a leveraged buyout. Valuation of other assets : In this section, you will find a model for valuing income-generating real estate.Takeaway: Determining the value of your business is the starting point to building value. Knowing the value of your company should be an integral part of the strategic planning process for all business owners.
There are some instances when a formal valuation is appropriate, such as selling the business or buying out shareholders, but for planning purposes this valuation template in excel will do just fine. This template uses a market approach by looking at comparable public company and comparable transaction multiples. It will provide you with an estimate of the value of your business give or take 15 percent. If your company is growing or declining at a significant rate greater than 10 percent year over year than this approach might not be appropriate and a discounted cash flow approach would be more applicable.
Click here if you would like to download the excel template. This is the most common metric used by buyers to assess the starting point for a valuation.
As the acronym suggests, add back interest, taxes, depreciation and amortization from net income to calculate the company's EBITDA. The template calculates averages over the years but a lot of judgment comes into determining the appropriate level.
You will need to find comparable public companies in your industry. Try to find at least five public companies that operate in a similar industry, region and provide similar services as your company. It would also be great if they were a similar size. It is difficult if not impossible to find an exact comparable that will match all of these criteria but do your best.
This step is a little more work. You will need to calculate the implied valuation multiple for each public comparable company selected. In our excel valuation template, this analysis is performed in cells AK27 of our 'Market Valuation' worksheet.
To do this, you need to find the following variables for each company:. With these variables, we can determine enterprise value stock price x no. In our excel valuation template, this analysis is performed in cells AK37 in the 'Market Valuation' Worksheet. There are many services that compile transactional data but you will have to pay to perform a search.Discounted Cash Flow (Part 1 of 2): Valuation
You can also get information on comparable transaction multiples from press releases or from the financial information of acquisitive public companies. Comparable transactions should be in similar industries, regions and size range. They should also be quite recent; any transaction completed three years before performing this analysis might not be that relevant because valuation multiples could have increase or decreased due to market conditions.A DCF valuation is a valuation method where future cash flows are discounted to present value.
The valuation approach is widely used within the investment banking and private equity industry. Read more about the DCF model here underlying assumptions, framework, literature etc.
4 Company Valuation Examples
On this page we will focus on the fun part, the modeling! In these coming 8 steps, you will be able to perform your own DCF Analysis.
Expand each section to follow the free! DCF-model tutorial. Now lets do some modeling!
Business Valuation Template
Sneak peek of the DCF valuation click to enlarge screenshots. The historical information will be used to make forecasts in the forecast period, to have something to compare with and base the forecasts upon. It is also great to use for the Output of the valuation. The projections in the DCF model have large impact on the valuation, therefore, this step is extremely important.
We will now use the historical information as a base in order to make good and likely projections of the future. In the picture below we have highlighted the information you should fill in. However read the instructions below the picture before you make your assumptions and input. Important: This section is for you who have access to a financial database such as Bloomberg, Reuters, FactSet or similar and know how to do trading comps. This is the most frequent used assumption when determining capital structure in a DCF model.
Or simply use a fixed WACC! However, the below described method is more accurate and preferred if you have all the needed tools. The picture describes the input we have made in our example valuation, which is further described below the picture. The capital structure is given from the previous step and works as a base for determining WACC in the calculation below. Nowdays 8. Next step is to calculate the present value of the generated cash flows in the projection period.
Most values are already given as can be seen below:.Valuation is the process of calculating the current worth of an asset or liability. Examples of assets are stocks, options, companies, or intangible assets. Concerning liabilities, they can be bonds issued by a company. Common terms used when discussing the value of an asset or liability are market value, fair value, and intrinsic value. Put simply, the value to be derived is the present value of all the future benefits or cashflow of the given asset or liability.
This can calculated in various ways, with the use of financial and valuation tools, to determine the magnitude and risk of such future benefits. Take the example of an analyst determining the value of a company. He will consider the company's management, the composition of its capital structure, the prospect of future earnings and market value of assets to come to terms with its value.
Comparable Company Comps Analysis : Also-known-as 'trading multiples', 'peer group analysis', 'equity comps', or 'public market multiples', a Comparable Comps Analysis uses information from similar companies, in terms of size and industry, to reach a valuation on the value of a company.
Estimating WACC for Private Company Valuation: A Tutorial
This method bases itself on the assumption that comparable organizations will have similar valuation values. Precedent Transaction Analysis : This method of valuation analysis looks at the price that has been paid for companies similar in size and industry in the past to help value another company.
Similar to the comparable comps analysis, due to the fact it is a relative model, the precedent transaction analysis may deliver an outdated valuation depending on when the merger or acquisition has taken place. This can be a complex method, requiring high levels of detail and intricacy. A DCF analysis is perhaps most accurate, and therefore useful, for companies with steady levels of income. Other examples of valuation models include the Leverage Buyout Analysis and the Cost Approach useful for real estate valuations.
It is common for a variety of valuation models used - the outcomes of each, such as the comparable comps, precedent, and DCF valuation models, to be mapped onto a 'football field chart. All in all, Valuation in finance is key for many reasons. It is needed in investment analysis, capital budgeting and acquisitions transactions, financial reporting, or taxable events. If you'd like some Valuation Excel Model Templates to facilitate your valuation, you will find the above valuation techniques and many more on the Eloquens catalogue.
Also, if you have any questions or would like to discuss matters about a given tool, you can contact our authors whom will happily get back to you. A more in-depth look at Valuation in general.For all of the expensive subscriptions and analytics programs, a huge amount of the work that Wall Street analysts and managers do is done on the Excel software that you have on your own computer.
With just a little bit of effort, you too can create a variety of financial and analytical models, and investing the additional time and energy to learn about macros can give you even more options.
Sell Side Analysts. These are simply spreadsheets that hold and help form the analyst's views on the likely financial results for the company in question. They can be incredibly detailed and complex, or relatively simplistic, but the model will never be any better than the quality of the work that goes into forming the estimates.
In other words, elaborate guesswork is still just guesswork. Financial Models are usually built with the x-axis serving as the time quarters and full years and the y-axis breaking down the results by line-item i. It is not at all uncommon to have a separate sheet generating the revenue estimate; whether that is a per-segment basis for a large conglomerate like United Technologies UTX or General Electric GE or a more simple units-sold-and-estimated selling price for a smaller, simpler company.
For these models, the model-builder needs to input estimates for certain items i. Although most would deny it, surprisingly few buy-side analysts actually build their own company models from scratch in my experience. Instead, they will essentially copy the models built by sell-side analysts and " stress test " them to see how the numbers respond to a variety of circumstances.
Even if you don't build your own company models, you should seriously consider building your own valuation models. Investors who want a more rigorous approach, though, ought to consider a discounted cash flow model. DCF modeling is pretty much the gold standard for valuation and plenty of books have been written on how free cash flow operating cash flow minus capital expenditures at its simplest level is the best proxy for corporate financial performance. There needs to be a starting estimate for "Year 1" and that can come from your own company financial model or sell-side analyst models.
You can next estimating the growth rates by creating individual year-by-year estimates or use "bulk estimates" that apply the same growth rate for Years 2 to 5, 6 to 10, 10 to 15 and so on. As part of this process, do not forget to calculate and include a terminal value most analysts calculate explicit cash flows for 10 or 15 years and then apply a terminal value. Investors must remember that detailed or sophisticated modeling is no substitute for judgment and discretion.
All too often, analysts lean too heavily on their models and forget to do the occasional "reality check" regarding their core assumptions. Nevertheless, building your own models can teach you a lot about what a particular company must do to grow, what that growth is worth and what the Street already expects from a particular company.
Accordingly, the relatively modest amount of time it takes to build these models can often pay for itself many times over by leading you to better investment decisions.
Tools for Fundamental Analysis. Fundamental Analysis.