A question that I always ask an entrepreneur is, “What do you think your company is worth?” The answer usually comes back very vague or maybe just simply, “I don’t know.”
When seeking capital funding it’s very important to have a fact based, analytical sense of what your company is worth.
After all, if you’re seeking equity financing you will be giving up a negotiated portion of your company in exchange for cash.
Admittedly, valuation is almost just as much art as science and everyone has their own way of doing it. Also, it’s very dependent on assumptions and how realistic you or an investor believes those assumptions to be.
It is also important to remember that an investor is going to be most interested in the value of your company at the time of exit via sale or public offering. You should conduct your analysis similarly.
There are several methods of valuing your company. Among them are price to earnings, discounted cash flow, price to sales.
When determining the value of your company I recommend that you take all 3 methods and see if the results are convergent. If they are and the assumptions you made are reasonable and defendable, you’re probably on the right track.
Let’s talk briefly about the methods we mentioned.
Price to earnings (P/E) is a ratio of the value of a company’s stock to its after-tax earnings. For instance, if a company’s stock sells for $20 per share and its earnings for the most recent year is $2 per share then the price to earnings ratio is 10.
In order to value your company using this method you will need to gather market data about the price to earnings ratios of publicly traded companies in your industry and make some assumptions about stock market performance at the time of your planned exit.
Price to sales is very similar to price to earnings except that it expresses the value of a company’s stock relative to its sales revenue.
Let’s say that our company whose stock price is $20 per share had sales in its most recent year of $20 per share. Its price to sales ratio is one.
Like price to earnings, this method will require gathering market data about the price to sales ratios of publicly traded companies in your industry and make some assumptions about stock market performance at the time of your planned exit.
The discounted cash flow approach is different to price to earnings and price to sales in that it does not estimate company value by comparison with publicly traded companies.
This method measures the cash flows at various points in the future and discounts them to the present and then sums them to arrive at a valuation.