How to value shares in a private company

How to value shares in a private company

Determining the value of a private company can seem to be very difficult, most entrepreneurs don’t know what their startups are worth. This is a guide on how to value shares in a private company.

Valuing shares of a public company is much easier, the share price is there for everyone to see. How do you value a startup? This also questions the assertions that ideas are worth anything on their own. There are two main ways to value the worth of a private company.

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Valuing the company using assets

The easiest way to value the shares of a company is first by valuing the net assets of the company. This means you have to take the value of all the assets that the company currently owns and subtract company debt. What you are left with is the value of the company at that point.

This is a method that is mostly used to value businesses that don’t have any revenue. Let’s say you register the business, buy a building and equipment. At that point your company is worth exactly what you spent on assets; you may add your labour on top.

A lot of traditional businesses that hold inventory are valued this way. Let’s say for example you start a blog, write 30 articles; how much would your blog be worth? In this case you would have to consider the value of each article, each article counts as an asset.

The main problem with this model is that it doesn’t take into account the market position of a business. A business may also not need to have as many assets, if it’s in the services sector. This model doesn’t take into account the value of a brand, this is the market cap of public companies is way more than company assets.

Using company revenue to determine value

Company revenue can be used to determine the value of a private company. This model proposes that you take the current profits of the business and multiply them by a number of years. The number of years differs from company to company, for most tech companies; the number is 15.

This is why tech companies are able to grow at such a staggering speed in valuation. The assumption is that the company will reach that amount of money in revenue within the next 3 years. For more traditional businesses that don’t have a high potential for growth; the number should be three years.

If a startup gets valued at 15 million today; it’s likely that they will make reach that amount in revenue within the next three years. This is because tech companies often grow at a staggering pace, revenue can growth by more than 300% in a year. Which is rarely the case for other types of businesses.

How to determine the price of each share

After getting the overall value of the business; you should divide it by the number of authorized shares of the company. A company can be authorized to issue any number of shares greater than 1. This number can be 10, 10k, 10million or even 100million. If the company is worth R10k and has been authorized to issue 10 shares; then the value of each share is R1k.

Conclusion

This was a guide on how to value shares in a private company in South Africa. Do you have any thoughts or questions? Comment below.

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