This post focuses on a calculator for estimating the enterprise value of private companies. It is primarily geared for technology companies, but the general principles can be applied to any business. Without access to actual financial statements one can only estimate the enterprise value of a private company. This post provides some guidance on how to gather the relevant information and a basic calculator for estimating the enterprise value of a private company. There are four major steps:
1. Estimate Revenue of Private Company
2. Determine Enterprise Value/Revenue Multiple
3. Discount Private Company Valuation
4. Estimate Enterprise Value
For detailed information about each of these steps check out How to Find the Revenues of Private Companies and How to Calculate the Enterprise Value of a Private Company. Summary info about each step is provided below.
Enterprise value is defined as:
Unless you have access to the private company’s financial statements it is practically impossible to know their cash balances, amount of debt, minority interests, preferred equity, unfunded pension liabilities, or value of associate companies. As a result, one can only develop a broad estimate of enterprise value for a private company based on estimating revenues, which is possible, and determining current market rates for Enterprise Value/Revenue ratios. The balance of this post focuses on how to make these estimates. The typical results are reasonably close to what the actual enterprise value would be, barring an the firm having an unusual amount of debt, or onerous liquidation preferences.
The process starts with estimating the company’s annual revenues. There are a number of free public resources that provide revenue estimates for private companies – Owler and Crunchbase are two of the best. A simple search of the company name often reveals an annual revenue estimate and where appropriate who has invested in each company.
Another approach is to use what is known as the headcount proxy. Companies that are in the same industry tend to have similar ratios of revenue/headcount and operating income/headcount. You can examine the filings of public companies to readily determine a range of ratios. In every 10-K Annual Report that is filed there is a section that lists the total number of employees. Simply divide that into the reported revenue to get revenue/headcount. Consider the following table:
To estimate the revenue for the company you are interested in, find the total employee count (LinkedIn, Owler, or Crunchbase) and apply the ratio from your example of their peers. You can use the same ratios for private competitors reported by Owler or Crunchbase. Consider this table for marketing automation providers:
One of the most common valuation metrics is the ratio of enterprise value to annual revenues. If you know the estimated revenues of a firm, you can probably find public references to EV/Revenue multiples for firms in the industry.
You can first start by looking to see if there are any public companies in the same market. Stocking tracking services like Yahoo Finance report daily on the enterprise value of public companies. Consider the following chart:
Another source of valuation information can come from various industry analysts. One of my favorite sources for technology companies is the Software Equity Group (SEG). Allen Cinzori and his team publish quarterly and annual reports on the state of M&A and valuations in the technology space. They also are pretty good investment bankers as well. Here is a link to their research reports.
Their most recent report provided these summaries of median public company EV/Revenue ratios by market segment for both SaaS companies and traditional licensed software companies:
You cannot apply the EV/Revenue multiples of public companies to private companies. Private companies are valued at a discount to public companies for a number of reasons:
- Public company revenues are often significantly higher than private companies
- Private company’s stock or equity is not liquid. Public company stock can be bought and sold everyday with transparent pricing
- Public companies financial records are audited annually. Many private companies are not.
- Public companies have to comply with transparency regulations like Sarbanes Oxley (SOX). Most private companies do not go through the formal CEO/CFO SOX section 404 certification
As a result, private companies are valued at anywhere from a 10% to 50% discount to public companies
You can use the following simple calculator to estimate the value of a private company