For an investor, hoping to invest in an early stage company, it is critically important that an early stage valuation of such a company should be carried out, in order to ascertain the real-time value of the company and the benefit it will yield in the long run.
Company valuation, helps an investor to ascertain, or, better still, have a clue as to what will be his/her percentage in the ownership of the company.
Over the years, there have been theories propounded on the best way to value an early stage company, but three methods stood out and they are still being used till date.
They are Discount Cash flow Analysis, (DCF), Comparable Company Analysis and Precedent Transaction.
These three methods have been used effectively, over time, to carry out an early-stage valuation of companies, by the industry practitioners, in almost all the areas of finance, starting from Equity Research, Private Equity, Corporate Development, Investment Banking, Leverage Buoyancy, and Merger & Acquisitions.
Discount Cash Flow,(DCF)Wikipedia defines Discount Cash Flow, as a method of valuing a project, company, or, asset, using the concepts of the time value of money.
With DCF, analysts tend to analyze the intrinsic value of the company, by forecasting the business cash flow, into the future and discount it back to the present, using the weighted average cost of capital, (WACC), to arrive at the current value. The Weighted Average Cost of Capital reveals the risk of the cash flow.
Comparable Company Analysis (COMPS)This is a method of valuation, in which the current value of a company is compared and measured to other businesses in similar industry, in order to ascertain the real value of the company.
Comparable Company Analysis, (COMPS), can also be called, Peer Group Analysis, Trading Multiples, Equity Comps and Public Market Multiples.
When valuing a company through this method, you have to look for a company that operates in the same sphere as the company you want to value. They should have similar characteristics in terms of size, growth rate, margins and profitability, etc.
Precedent TransactionPrecedent transaction can also be called, Mergers & Acquisitions, (M&A), transaction and it is a method that involves comparing the value paid for the company in the past to determine its current worth.
This type of validation is commonly used by the industry practitioners, when it comes to gathering information on how much a company is worth, in case of an acquisition, although it can be a little bit difficult, when gathering information through this method, as information may not be accurate, due to the fact that transactions recorded happened in the past and the data used back then, may no longer be relevant.