While there are different possible techniques in assessing the value of a company—a lot of which are company, industry, or situation-specific—there is a relatively small subset of generally accepted valuation techniques that come into play quite frequently in many different scenarios.
Comparable Company Analysis (Multiple Method):
Evaluating other, similar companies’ current valuation metrics, which are determined by market prices, and then applying them to the company being valued.
Discounted Cash Flow Analysis (DCF):
Valuing a company by forecasting its future cash flows and then using the Net Present Value (NPV) method to value the firm’s entity.
The cost method is also known as the Depreciated Replacement Cost (DRC) method of valuation is a method of evaluating the value of a property or an asset by reference to the cost of replacing the property or asset as new, then making allowance for depreciation to take care of wear and tear and other forms of obsolescence.
Choosing which valuation method is best depends on the factors surrounding such a valuation. Each valuation method has its own set of pros and cons. Some are more reliable and accurate, while others are just easy to perform, for example. Furthermore, some valuation methods are specifically used in certain circumstances.
Here are some of the main Pros and Cons of each method:
Comparable Company Analysis (Multiples Method):
Advantages: Market efficiency and effectiveness ensure that merchandise values for comparable companies serve as a reasonably good indicator of value for the company being evaluated, as long as the comparable are chosen wisely. These comparable should reflect industry trends, business risk, market growth, and so on.
Disadvantages: No two companies are exactly the same, and as such, their valuations generally should not be the same either. Thus, comparable valuation ratios are often an inexact match. Also, for some companies, finding a decent proxy of comparable (or any at all!) can be a very challenging task. Hence Comparable company analysis is always running the risk of “comparing mangoes to oranges,” never being able to find a true comparable, or simply having an insufficient set of comparable valuations from which to draw.
Discounted Cash Flow (DCF) Analysis:
Advantages: Theoretically, the most sound method if one is very confident and certain of the projections and assumptions, because DCF values the individual cash streams (the actual source of the company’s value) directly.
Disadvantages: The DCF method is not heavily affected by temporary market conditions or non-economic factors.
Advantages: The valuation derived is very sensitive to modelling assumptions—particularly growth rate, profit margin, and discount rate assumptions—and as a result, different DCF analyses can lead to wildly different valuations.
Disadvantages: DCF requires the projection of future performance, which is very subjective, and most of the value of the company is usually derived from the “terminal value,” which is also the set of cash flows that occur after the detailed projection period, which is for an unforce able period of time (and is therefore usually projected in a very simple way).
Advantages: It is most reliable for new assets with a relatively modern design in a stable market.
Disadvantages: It is less reliable for old assets as it is hard to estimate the depreciation of properties that are older.
Tips For Startups In Selecting A Valuation Model
- Consider the businesses in your industry and geographical area and what valuations they’ve received and how much money they’ve raised. This will give you an indication of what to expect.
- Do not just stick to one valuation model. Both investors and startup owners use several startup valuation methods because they help them reach a better average valuation.
- Get the service of a financial advisor (at GFA we can advise you on this) to help you decide on the best valuation methods for your business, support you with various valuation services, and conduct them for you.
Determining the exact value of a startup is not an easy task. Every startup is unique and there are many factors at play, such as industry, sector, geographical location, and the startup’s stage – just to mention a few.
There’s no single startup valuation model that’s the best, that’s the most precise, or that’s a-must to use. All methods eventually rely on estimates and forecasts.
If you need help evaluating your startup, then get in touch with the GFA team and we’ll help you and your business by conducting those valuation methods.
This article was created by Adekunle Adebimpe, Product Manager Start-up/Investor Relation at GetFundedAfrica. He produces a weekly column titled “Financial Intelligence,” which provides start-up founders and entrepreneurs with a deep dive into the investment world as well as the information they need to operate a successful business.