6 Steps to Company Valuation

Discover the 6-step process for effective company valuation. From defining financial metrics to assessing market trends, this article breaks down the essential.

The Blackroom Team
The Blackroom Team

The valuation of a company responds to a quite standardized process. Several methods exist and can even be combined, based on a more or less complex formalism. The most pertinent method for each situation will depend on:

- the size of the company: the bigger, the more parameters to include, quite logically 

- the sector of activity: the criteria will vary for SaaS companies vs services companies for instance

- the method of consolidation of the subsidiaries within a group. 

The final value of a business is only the conclusion of this process. Despite everything, the principles and the general methodology remain quite similar. Keep in mind though that even with a framework, business calculation can vary from one analyst to another and remains a tricky exercise.  

As an example, for mature and profitable ventures, the most used KPIs will be multiple of their EBITDA, with a different base multiple depending on the vertical. High growth startups, not profitable yet, have most generally been valued based on their past revenue growth and potential in the future. Although the current bear market context may influence this trend.

No matter the type of company, we can identify six key steps necessary that constitute the core path to follow when evaluating a company’s worth. 

1. Define Financial Metrics: Start by identifying key financial metrics such as revenue, EBITDA, and net income. These figures provide the foundation for various valuation methods.

2. Choose Valuation Methods:
Select appropriate valuation methods based on the company's nature and industry. Options include the Income Approach, Market Approach, and Asset Approach.

3. Gather Comparable Data:
Collect data from similar companies in the industry. This comparison helps determine the company's relative value and potential market position.

4. Assess Market Trends:
Understand market trends, growth rates, and potential disruptions. These insights influence the company's future cash flows and risk factors.

5. Calculate the Valuation:
Apply chosen valuation methods to the company's financial data and comparable information. This step determines a preliminary valuation range.

6. Refine and Interpret Results:
Adjust valuation figures based on company-specific factors and market conditions. Interpret the results to make informed decisions.

Want to go deeper into each step? More details on each steps below.

Step 1: Gather the data

The first step consists of collecting all the information you can find on the company and its surroundings: products and services, markets, competitors, key figures, founders / managing team and so one. To achieve this, you will have to mix data sources. 

Public data such as the company website or its competitor’s, published accounts, press articles or basically a tool such as LinkedIn will give you the most common KPIs along with a first idea of key trends: major milestones in the lifespan of the company, headcount fluctuations, basic financials and so on. More specific databases have emerged in the past decade such as Crunchbase or Dealroom.co. There are pletoric amounts of database websites out there and we recommend you to focus on the top 3 that are the most relevant to your needs.

Private data will go more in depth and allow you to find sector studies, more hidden KPIs - sometimes EBITDA if you’re lucky, or notes from financial analysts on the company or at least its market. 

Whether the data is private or public, aside from the company and competitors’ websites, we recommend you to focus on a top 5 data sources depending on your needs. And ideally the ones that have the most structured data, which will allow you to automate as much as possible this step.

Once you have collected all that data and synthesized it, you will have a pretty good theoretical understanding of the business. This general knowledge of the company is most often supplemented by interviews with top management and operational management, as well as by site visits in the field. Those are critical to give you a better pulse of their execution process and give brighter colors to the facts and numbers you will have assembled.  

Step 2: Understand the business model

This second step serves above all to understand the business model of a company (or a group) from a strategic and financial point of view.

The strategic analysis makes it possible to take a look at the competitive situation of the company, the opportunities offered on its market and to characterize its strengths and weaknesses. Concretely, use all the data you have collected, the notes and documents from your meetings with the top management and operational leaders. From there, you can go a step further and analyze the main components of their corporate strategy: vision - and how it is declined in objectives ; allocation of resources ; prioritization.

The financial analysis is nothing more than going through the numbers supporting the strategy and how their correlation makes sense. It makes it possible to identify the determinants of the business and financial performance of the company over the long term, to analyze its financing structure and to assess its financial solidity.

Step 3: Choose the right evaluation method

Once you have finished the two previous steps, you are still prior to any evaluation per se. The corporate strategy analysis and financial analysis are all the more important as they will condition the choice of the evaluation method. 

Here are the three most commonly used methods:

  1. the patrimonial approach 
  2. the analogical method 
  3. the actuarial method 

The patrimonial value is the first element of valuation of a company. The advantage of this method is its ease of implementation: it consists of determining the price of a company by adding the real value of all the goods that make it up and subtracting all the debts. This calculation is made from the company's balance sheet. But this method is turned towards the past, it does not consider future profits, or off-balance sheet elements: notoriety, know-how, etc.

Patrimonial methods are relevant for the valuation of companies that have significant assets and whose profitability is not very high (real estate company, industrial activity) but will be less appropriate for service provision activities.

The valuation of a company via the comparable companies approach consists in using the data collected in the peer group or the sector of activity to define an average of ratios. The ratios will then be used to determine the value of the business. This method is common for determining the value of a listed company.

This method has many advantages as it is reactive to the market. It provides information on the market price at a given time. The valuation of the company is generally close to reality. But on the other hand, this approach does not give the asset value of a company, which would require accessing accounting data of comparable companies. 

When determining a company value based on the actuarial method, a discount rate will be defined taking into account future cash flows, which most reflect the wealth of the company. This rate is used to determine the level of risk of the company. The flows considered can be:

  • Dividends distributed: often chosen for industrial companies;
  • Cash flows: chosen for growing companies;
  • future profits of the company.

The choice of the method depends on several factors: the characteristics of the company, the objective of the buyers and the investment horizon. But more pragmatically, this choice also depends on the availability of data or market conditions at the time of the assessment. 

Step 4: Build a business plan for the next 3 to 5 years

On a theoretical level, actuarial methods are generally the most appropriate because they assume that the value of a company is equal to the present value of the cash flows generated by its activity. However, this type of method requires the development of a business plan and the assessment of the amount of potential synergies in the event of a merger with another group. 

The business plan is based on a number of assumptions related to changes in cash flows, WCR (Working Capital Requirement) growth or capital expenditure. Here again, step 1 and 2 will be of crucial help if you want your hypotheses to be receivables.

Step 5: Determine valuation hypothesis and parameters

Like any other models that seek to anticipate market trends, valuation models are based on numerous hypotheses, both reductive and simplifying, which concern the construction of the business plan or calculating the discount rate. You will need at least three versions: worst case scenario, best case and realistic.

The valuation obtained only makes sense in relation to the assumptions made. Hence the importance of testing the robustness of the hypotheses by modifying certain parameters (scenario analyses) or by carrying out simulations. The Monte Carlo method is one of them: those simulations are algorithms used to estimate the probability of occurrence of a scenario involving random parameters. 

Step 6: Build a range and conclude on the value

The objective of any business valuation is not to assign a unique value to a company, because one does not exist. The appraiser or analyst should instead seek to construct a range of values ​​by identifying the minimum and maximum values. Valuation methods should only be considered as decision-making tools for managers and investors. 

At this stage, acquisition audits / due diligence can be carried out by both parties (buyers and sellers) in order to verify the value of certain assets and liabilities. 

Once the due diligence process and acquisition audits are carried out, the negotiation phase can then begin. All parties (sell side, buy side and third parties) will rely on the evaluation work and the conclusions of the audits. At this stage, advisors (bankers, lawyers) will help sellers and buyers set a transfer price and negotiate the terms and clauses of the transfer contract.

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