Thursday, August 9, 2012

How much is your private company worth?

You may have a great clientele, a super high turnover or a perfect business model, but the one thing that matters the most to an investor is "How much is your company worth?" and "What is the valuation of your company?"

There are many established procedures to arrive at an early valuation for a company. The method ultimately selected also depends on a company's profile and is sector-specific.

NAV: One of them is called the Net Asset Value (NAV) method. This is the most common method. Under NAV, you take together all the assets of your company like the machinery, the office furniture, the vehicles, etc and arrive at their total worth. It is then divided by the total number of shares and you get the value of per share. 
Cash flow:The second way is the earnings and cash flow based method. Some experts consider this to be the most accurate and effective way of establishing a company's value, especially from an investor's viewpoint. In this method, future cash flows are taken into account, i.e how much of cash or money is likely to come into the company over X  or Y period. Based on that, the evaluator will ascertain how much an investor will gain on his investment. Eg: If an investor puts in Rs 10 lakh today, this method will tell him how much he will earn on his Rs 10 lakh investment in the next, say 5 years.

Liquidation value:
There's a 3rd way called liquidation value. Like book value, liquidation value is based on a company's assets. It is the amount of money one can get by selling off all the assets of the company. So, for example, you do know that the land on which your plant stands and its equipment will fetch some value as of today, if sold.  That is one factor. The other factor in this method of evaluation is the inventory of your company and the receivables. These, though, be factored in at discounted rates. 
Eg: Inventory would be the raw material in your stores, while receivables is the monies your company has to receive.
Some experts believe in valuing a company based on its cash flow and in-built ability to earn profit.  The seller then projects this stream of cash over a period of time, say 5 or 10 years, to arrive at the company's worth.

Early Calculation:

"For an early calculation, one should benchmark against a listed company in the sector and then give a discount. For startups, at least 30 percent discount is a must to arrive at the value," says Ambareesh Baliga, COO, Way2Wealth Broking. 
Factors taken into account for evaluation:
> Annual turnover 
> Profitability of the company
> The future prospects
> The sector your company is in 
> How established your brand is
"The balance sheet is also very important," says Santosh Naik, MD and CEO, Disha Direct.
Examples:a) If you have established that your company is say worth Rs 20 lakh, and if you then want to sell off 25% equity to an investor, the money you will get by doing that will be Rs 5 lakh. 
b) If you were to sell 25 percent stake in your company for Rs 3 million, your company is then said to have a total value of Rs 12 million, even though you may have initially invested only Rs 2 million in it.
Normally, you must carry out an evaluation of your company after about three years of operations. By that time, you, the promoter would have generated enough data and feedback of your company's operations.
Can you, as an entrepreneur, calculate your company's worth on your own? Yes, an entrepreneur can do it.  But he needs to have the  knowledge to do so. It is always better, though, to appoint a valuations firm. A third party valuation is always preferred by investors. Anyway, business valuation is a complex task and should be left to the experts.

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