Why are they almost never the same?
In business valuation, it’s important to distinguish between price and value because – while sometimes they’re seen as the same – in practice, they’re often quite different. This dynamic is especially true in valuing small private companies, where data is typically incomplete and opaque, and markets are illiquid and rife with information discrepancies.
When we were developing EquityMaven back in 2018-19, we thought it was an interesting time in the world’s economy. Why? Well, the wealthiest generation in American history needed to pass down its riches (around $68 trillion to be precise*) – which is rather a lot of money to move around. Many Baby Boomers (those born between 1946 and 1964) were reaching either the end of their working careers – or the end of their lives.
How do you go about getting the true and fair market value of a business? Whether you’re buying or selling (or investing, insuring or advising!), valuing a company can be a complex and lengthy process, so here’s a more detailed explanation of how it all works.
When it comes to valuing a business, there are several methodologies you could use. Each methodology is different, with distinct advantages and disadvantages that may make them more suited to certain scenarios.
You may recall from our valuation methodology or time value of money blog posts that our primary valuation technique – the Discounted Cash Flow (DCF) method – relies on a Discount Rate. Although there are good reasons to use (or at least test!) other rates, the appropriate Discount Rate to use for a DCF is often the company’s weighted average cost of capital or “WACC”.
Valuing young companies is a difficult task. Because a new company is early on in its lifecycle, it can be hard to project what it will be worth in future – especially when it has no established products or services yet. So, how do you go about valuing it accurately?
When it comes to valuing a company, it’s crucial to understand the difference between equity value and enterprise value. At their simplest, the two concepts can be defined as follows:
Similarly sized and spec’d houses in the same neighbourhood should have similar asking prices, should they not? The multiples approach is a theory of valuation based on this same concept: that similar assets sell at similar prices. It assumes that a ratio comparing value to a firm-specific variable, like operating margins or cash flow, is the same across similar firms.