Demystifying private company valuations

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Hey folks, this week we’re going to dive into the weird and wonderful world of private company valuations. Most would consider the valuation process more art than science, and the earlier the company, the more accurate this statement becomes.

Unlike private companies, public companies are required to publish vast amounts of financial data to their shareholders. This, in combination with the liquidity of the stock market, makes the valuation process relatively straightforward. Valuations of private companies on the other hand are based mostly on potential, assumptions, and negotiation. This of course makes the process far more subjective and complicated.

Let’s first take a look at how public companies are valued. In public markets, valuations are driven by financial performance, market data and comparable companies. Investors will typically use metrics such as price-to-earnings (P/E) ratios, discounted cash flow (DCF) analysis, and earnings before interest, tax, depreciation, and amortisation (EBITDA) multiples. Ok no more acronyms, I promise! Importantly, these valuation methods are backed up by publicly available financial reports and regulatory filings. In addition to this, public companies are listed on stock exchanges where their prices fluctuate in real time based on supply and demand, adding market sentiment to the overall valuation.

Private companies on the other hand operate in more opaque environments with far less objective data points available to supplement the process, making accurate predictability almost impossible. Because of this, private company valuations are based less on historical financial performance and more on potential future growth. At the earliest stages of growth, revenue might not even exist yet, so valuations are typically based on the quality of the founding team, the size of the market they operate in, and how quickly they’re acquiring new users.

• Founding team – This is where investors place most weight in early stage deals. How credible are the founding team? Why are they the right team to solve this problem? Do they hold domain expertise in their market? Have they built a company before?

• Market opportunity – How big is the market the company is targeting? Does the market show strong growth? How big could the market become? What adjacent markets might the company be able to move into?

• Traction – How quickly is the company acquiring new users? Have they formed any key strategic partnerships? Is there strong market demand for their product? How much cash are they burning? Are they able to find and hire best-in-class employees?

These are just a few areas investors will use to form a valuation. Here’s a rudimentary example of how it might pan out: Company needs to raise €1 million and is willing to sell 20% equity in exchange for the capital. This implies a valuation of €5 million. Based on recent valuations of comparable companies and the criteria above (team, market, traction etc.), is the investor comfortable with the implied valuation? Yes? Make the deal happen. No? Pass on the deal or negotiate a better valuation.

So in summary, and as you can probably tell by now, private company valuations are highly subjective. You’ll often find the exact same company valued markedly different by numerous investors. Macroeconomic conditions, competitive dynamics, and the overall startup ecosystem all play their role in defining these valuations. Finally, I think it’s important to note that these valuations are not a definitive statement of what a company is worth, it’s just a consensus based on what a group of people believe is the potential future value of a company.

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The Unsophisticated Investor is brought to you by Scott & Rob, the founders of Shuttle. We’re both sick of private markets being a playground exclusive to the ultra-wealthy so we started a company to challenge the status-quo. Shuttle’s singular focus is to unlock private markets for Millennial and Gen Z retail investors and help them build wealth through the highest performing private market opportunities.

Scott & Rob
Shuttle Co-Founders