Even though a public company’s net worth is relatively easy to find out, estimating the net worth of a Private company is relatively more difficult. Procedures and methods used to evaluate a private company’s net monetary value are called Private company valuation.

In the case of public organizations, you simply have to multiply the company’s stock price with its outstanding number of shares. Since the organization is public, you can find these values with ease on various databases.

However, in the case of a private organization, stock value is not publicized, making data retrieval and consequently calculation of value tricky.

Following are the most commonly used methods for valuing private companies:

1.  COMPARABLE COMPANY ANALYSIS (CCA)

In this method, you make a group of companies with similar characteristics and make assumptions that all companies that are categorically same have similar multiples. The companies whose multiples are used to calculate the private firm’s net worth are public, and thus their assets and stock value is also public.

The procedure for applying this method is calculating the average of the multiples of similar firms to that of our subject firms. An example of this is the EBIDTA multiple which is used to depict the company’s free cash flow. You use the following formula for calculation:

Value of subject company= Multiple x EBITDA of the subject company

Here, the Multiple represents the average of Enterprise Value/EBITDA of public firms in the group, and the EBITDA of the subject company is typically predicted for the next year.

•  DISCOUNTED CASH FLOW (DCF) METHOD

In this method, we begin by identifying the revenue growth rate for the subject company, by calculating the growth rate average of similar companies. The next step is to predict the company’s revenue, expenses, taxes, etc., and via these values, we find out the free cash flows of the subject company (usually for a 5 year period). The following formula is used:

Free cash flow = EBIT (1-tax rate) + (depreciation) + (amortization) – (change in net working capital) – (capital expenditure)

The company’s WACC-weighted average cost of capital is calculated and determines the discount rate. Cost of equity, cost of debt, tax rate, and capital structure are the parameters that should be known to calculate the company’s WACC. CAPM model is used to calculate the cost of equity by taking average beta of industry, while the cost of debt is calculated via its credit profile. Tax rate and capital structure are determined through industry average of similar companies. Through debt and equity weighting, debt cost and equity cost, WACC is calculated.

•  First Chicago Method

This is a mixture of 2 valuation methods which are, the DCF method and the multiple-based valuation method, and thus takes into account several scenarios and parameters of the subject company’s payoffs. In this method, three cases are formed: A best case, a base-case, and a worst-case scenario, along with assigning a value of probability to each.

For each scenario, we project cash flows and growth rate and terminal worth of the subject company via the Gordon Growth Model. After this, the valuation of each case is conducted through the DCF method and we estimate the valuation of the subject company through the average probability-weight of all scenarios. This method reflects the company’s upside potential as well as its downside risk.

The 3 methods are most popularly used to calculate whether the private organization is worth investing in.