How to Value a Private Company for Acquisition

A publicly-traded company can be valued easily enough by simply multiplying the stock price by number of outstanding shares. However, the process is more complicated for private companies and often lacks the necessary transparency due to the absence of public financial reporting and unavailability of stock price information.

M&A valuation experts have the complete knowhow of the various nuances involved in private company valuation and can help steer decisions, pricing, and negotiations during merger and acquisition, paving the way for successful deals.

Factors to Consider in a Private Company Valuation

Private company valuation goes beyond looking at the standard financial metrics, there being several other factors to consider.

Industry conditions: The industry and prevalent market conditions impact valuations with indicators such as entry barriers, competitive landscape, and growth potential acting as important determinants.

Intellectual property assets: Valuable intangible assets such as patents, proprietary technology, and intellectual property contribute to private company valuations and serve as a competitive advantage over potential competitors.

Relationship with customer base: The size of the existing customer base, their loyalty to the company’s products and services, long-term relationships, recurring revenue, and diversification are all important valuation drivers.

Risk factors: A comprehensive risk evaluation is crucial to private company valuations with factors such as over-reliance on key customers or suppliers, operational risks, market volatility, and regulatory compliance all determining the final valuation outcome.

Valuation Methods and Approaches

There are three different approaches to valuation for mergers and acquisitions. Each approach can be used individually or combined.

Asset-Based Approach

As the name suggests, in an asset-based approach, the net asset value of an entity forms the basis. This is usually seen when valuing the acquire company as a going concern or during the liquidation of assets. Such an approach is feasible when the target company, such as an industrial equipment manufacturing company, has predominantly tangible assets on its balance sheet.

Income Approach

One of the most common valuation approaches involves projecting economic income or future cash flows from all possible revenue channels—including dividend income from relevant sources—discounted to the current value, thereby factoring in investment risk and the time value of money. The discount rate used to determine the present value of projected future cash flows represents the return expected by the investor on the invested amount.

Market Approach

In this approach, companies similar to the target entity are identified, and based on this a minority interest market value is derived. This allows the valuation adviser to adjust multiple results provided by a minority interest value to arrive at a control interest value. This multiplier also represents the relationship between the target company’s gross purchase price and its book value.

Choosing the Correct Valuation Model

A one-size-fits-all approach cannot be taken when it comes to a private company valuation. Various factors need to be taken into consideration including the context and purposes of the valuation, the quality of available data, company expectations, and assumptions made by the professional.

Overall, the income approach has been found to be largely suited for private company valuations as it deals with the long-term, intrinsic valuation of the target company and its cash flow potentials. Use of multiple models is often recommended to arrive at a more realistic and balanced valuation.

Private Company Valuation Challenges

There are unique challenges associated with private company valuations that need to be carefully navigated to arrive at a fair valuation. Some of these are highlighted as below.

  • Limited availability of market data makes it a challenge to identify relevant comparable transactions.
  • Lack of sufficient financial disclosure.
  • Highly subjective assumptions of future prospects, leading to wide variations in valuations by different stakeholders.
  • Illiquidity of private company shares makes it difficult for investors to exit, and impacts valuations.
  • Concentrated ownership with few shareholders leads to significant influence in decision-making and impacts fair valuation of minority shares.

Choosing the Right Valuation Advisor

Business valuation can be complex which is why it is best to seek guidance from a reputed valuation adviser such as RNC. They will not only help you understand all the finer details of the deal but also perform a valuation in compliance with applicable FEMA, SEBI, and Companies Act regulations.

Entering into an acquisition deal may look like a leap of faith, but with proper guidance from a leading business valuation advisory service, you can turn your business into the next big corporate success story.

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