Unlike public companies, private companies do not have a clear market price that tells owners and buyers what the business is worth. As such, valuing a private company requires an appraiser to examine its financial performance, normalize earnings, assess company-specific risks, and compare the business with market trends. This analysis can help owners, buyers, and their advisors make informed decisions about a sale, acquisition, financing, ownership transfer, or estate planning. Below, we explain how appraisers analyze these factors and determine the value of a private company.
Peak Business Valuation is a trusted business appraisal firm. We regularly support owners, buyers, and their advisors by providing a private company valuation. Our experts apply accepted methodologies to provide an objective conclusion of value to guide decisions. If you have questions about valuing a private company, schedule a free consultation below.
How Is a Private Company Valuation Different?
A private company valuation calls for added judgment because there is no quoted share price. Financial reporting also varies widely between businesses. Furthermore, many private companies mix in the owner’s salary, related-party transactions, personal expenses, or nonrecurring items that affect reported earnings.
In addition, private transaction data is less visible than public market data. An appraiser may need to draw on private transaction databases, public company data, industry research, and company-specific evidence. This provides a reliable view of the private company’s fair market value.
Key Steps When Valuing a Private Company
Professional appraisers follow a structured process when valuing a private company. The appraiser first analyzes the financial statements. Next, the appraiser applies the appropriate valuation approaches and determines the conclusion of value.
Step 1: Determine the Company’s Normalized Earnings
Normalized earnings reflect the company’s ongoing financial performance under the assumptions of the valuation. The appraiser reviews historical financial statements, tax returns, interim results, and other supporting records. This helps identify adjustments that affect ongoing operations.
Common valuation adjustments may include adding back the owner’s salary, personal expenses, one-time legal costs, related-party rent, nonoperating income, and unusual gains or losses. For smaller owner-operated businesses, Seller’s Discretionary Earnings (SDE) is often the relevant metric. Appraisers often analyze larger private companies using adjusted EBITDA or cash flow instead.
These adjustments can siginificantly affect value. For example, a company reporting $500,000 in EBITDA may show a higher or lower normalized earnings figure. This depends on how the appraiser treats owner pay, one-time expenses, and related-party transactions.
Step 2: Apply the Appropriate Valuation Approaches
A private company valuation may use the income approach, market approach, asset approach, or a combination of the three. The appraiser must determine the applicable approaches, accounting for the quality of available data, and the purpose of the appraisal. To learn about each valuation approach, check out Common Business Valuation Approaches.
If you are seeking a credible private company valuation, it is best to work with a certified business appraiser. Peak Business Valuation follows a structured process using the proper valuation methodologies. We can explain why particular approaches and methods fit your specific company. If you have any questions about the private company valuation process, schedule a free consultation below.
Step 3: Evaluate the Company’s Risk and Value Drivers
In addition to earnings, company-specific risk has a major impact on value. Two companies with similar earnings can carry very different values. This is because their revenue quality, management structure, market position, and operating risks differ.
As such, an appraiser may evaluate value drivers such as:
- Customer Concentration: Heavy reliance on one or two customers can increase uncertainty if those relationships are lost.
- Owner Dependence: A business that relies heavily on one owner for sales, operations, or technical knowledge can carry added transition risk.
- Financial Trends: Consistent revenue, margins, and cash flow generally reflect lower risk than declining or volatile results.
- Management and Employees: An experienced management team and a stable workforce can reduce dependence on the owner.
The business appraiser considers these factors when selecting capitalization rates, discount rates, valuation multiples, or other valuation inputs. As such, focusing on key value drivers in business valuation can help minimize risk and increase fair market value.
Step 4: Move From Enterprise Value to Equity Value
When valuing a private company, it is important to understand what the final value actually represents. Different types of value can show different parts of a company’s overall worth. Enterprise value represents the value of the business as a whole, while equity value represents the portion of that value that belongs to the owners. The two values can differ based on factors such as cash, debt, and other assets or liabilities.
It is important for appraisers to clearly separate enterprise value from equity value because the distinction can affect decisions when buying, selling or financing a private company. Understanding the difference helps buyers, sellers, and lenders determine the amount of value involved in a transaction.
Step 5: Prepare the Valuation Report
A business valuation report explains how the appraiser reached the conclusion of value. The report identifies the company, the ownership interest, the valuation date, the purpose, and the standard of value. It also describes the financial information, adjustments, valuation approaches, assumptions, and conclusion of value.
The report should also explain the appraiser’s judgment. For instance, the appraiser may normalize historical earnings or rely more heavily on one method. In these cases, the report should describe the reasoning behind that choice.
When Should You Obtain a Private Company Valuation?
A private company valuation is useful when a decision depends on the economic value of the business or an ownership interest. Common situations include:
- Selling a Business: A private company valuation gives owners an independent view of fair market value before they enter negotiations.
- Buying a Business: A valuation gives buyers an independent conclusion of value to compare against the purchase price and review the assumptions behind it.
- Financing: A valuation gives lenders an independent basis for underwriting a business acquisition or other credit transaction.
- Ownership Transfers: A valuation can support partner buyouts, shareholder transfers, succession planning, and other changes in ownership.
- Tax and Estate Planning: A business valuation for estate planning supports gift, estate, and other tax matters. These often require an independent value of the business or a specific ownership interest.
Peak Business Valuation regularly helps owners, buyers, and their advisors with a private company valuation. Schedule a free consultation today if you have questions about valuing a private company.
Conclusion
Valuing a private company involves analyzing normalized earnings, valuation approaches, company-specific risk, balance sheet items, and the ownership interest. With a credible private company valuation report, business owners and advisors can make informed decisions to achieve their objectives.
Peak Business Valuation regularly provides independent business valuations for owners, buyers, and their advisors across the United States. We can provide valuations for transactions, financing, ownership transfers, tax matters, and other planning needs. Schedule your free consultation with Peak Business Valuation below to get started.
