Let's be real for a second. If you're trying to figure out how to value a privately held company, you've probably already realized it's nothing like looking up a stock price on Yahoo Finance. It’s messy. Private companies don't have a ticker symbol. There is no "market price" until someone actually cuts a check. You’re basically trying to solve a puzzle where half the pieces are hidden under the rug and the other half belong to a different box.
Most people think it’s just about multiplying profit by some magic number. It isn't. Not even close.
The Problem with "Market Value" in Private Markets
Public companies like Apple or Nvidia have their values updated every millisecond. The "Efficient Market Hypothesis" suggests that all known information is baked into that price. But for a local manufacturing plant in Ohio or a SaaS startup in Austin? Information is asymmetrical. The owner knows everything; the buyer knows what the owner chooses to show.
This gap creates friction. Honestly, the valuation of a private firm is often less about math and more about leverage and risk perception. You’re valuing a future that hasn’t happened yet, based on books that might be, let's say, "optimistically" managed.
Why the Income Approach is King (and Where it Breaks)
The most common way to handle how to value a privately held company is through the income approach. This is where we look at the cash the business actually spits out. You’ve likely heard of SDE (Seller’s Discretionary Earnings) or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
SDE is usually for "main street" businesses—your dry cleaners, your coffee shops. It's the total financial benefit to a single owner-operator.
EBITDA is for the bigger fish.
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The Discounted Cash Flow (DCF) Reality Check
The DCF is the gold standard in textbooks. You project future cash flows out five or ten years and then "discount" them back to what they’d be worth in today’s dollars using a discount rate.
But here’s the kicker: a 1% change in your terminal growth rate can swing the valuation by millions. It's incredibly sensitive. In private equity, we often joke that a DCF is just a way to make any number you want look scientific. If you're valuing a stable, boring company with twenty years of flat growth, a DCF is great. If it’s a high-growth tech firm? It’s basically guesswork with a tuxedo on.
The Market Approach: Finding Your "Comps"
You look at what similar companies sold for recently. Sounds easy, right? It's not.
In real estate, you can see what the house next door sold for because it's public record. In private business, those sale prices are often kept under NDA (Non-Disclosure Agreement). You have to rely on databases like Pratt’s Stats (now DealStats) or BizComps.
When looking at multiples, remember that context is everything. A 4x multiple for a HVAC company might be standard, but if that company has 90% of its revenue tied to one single contract? That multiple is going to crater. Customer concentration is a silent killer of valuations. If your biggest client leaves, the business dies. No buyer will pay top dollar for that risk.
Asset-Based Valuation: The Floor
Sometimes, the business isn't making much money, but it owns a lot of stuff. This is the "Asset-Based Approach." You add up the fair market value of the equipment, the real estate, the inventory, and the intellectual property.
This is usually your "floor." If the valuation based on earnings is lower than the value of the physical assets, you’re basically looking at a liquidation scenario. It’s a somber place to be. You aren't buying a "business" at that point; you're buying a collection of things.
The "Add-Back" Game
This is where things get spicy. Private owners love to run personal expenses through the business to lower their tax bill. You’ll see "company cars" that are actually the spouse's SUV, or "travel expenses" that look suspiciously like a family trip to Disney World.
To find the true value, you have to do "recasting." You add those personal expenses back into the profit.
Wait, be careful. I’ve seen owners try to add back "owner's salary" as a pure profit. That only works if the buyer doesn't plan on working. If the buyer has to hire a manager to do the owner's job for $100k a year, that $100k isn't profit. It's an expense. Period.
Why Multiples Are Often Wrong
You’ll hear people say, "Software companies trade at 8x revenue."
Maybe.
But is that recurring revenue? Is the churn rate 2% or 20%?
A company with $1M in revenue and a 95% retention rate is worth vastly more than a $2M revenue company that loses half its customers every year. Quality of earnings matters more than the quantity.
The Role of Risk (The Cap Rate)
In valuation, risk and value are inversely related. The higher the risk, the lower the value.
Professional appraisers use something called the "Build-up Method" to determine a capitalization rate. They start with a risk-free rate (like Treasury bonds) and start piling on "risk premiums."
- Equity risk premium.
- Industry risk premium.
- Size premium (smaller companies are riskier).
- Company-specific risk (the "Key Person" risk).
If the founder is the only one who knows how to run the proprietary machine, and they're leaving after the sale, the company-specific risk is through the roof.
Real World Example: The Tale of Two Bakeries
Imagine two bakeries, both making $200,000 in annual profit.
Bakery A has a manager, documented recipes, and a 10-year lease in a booming neighborhood.
Bakery B is run by "Nana," who keeps the recipes in her head and hasn't signed a new lease in five years.
On paper, they look identical. In reality? Bakery A might sell for a 4x multiple ($800,000). Bakery B might struggle to sell for 2x ($400,000) because the risk of Nana leaving—and the lease ending—is too high. That is the nuance of how to value a privately held company that a simple calculator won't tell you.
The Intangibles: Brand and Goodwill
Goodwill is the "plug" figure. It’s the difference between the fair market value of the assets and the actual purchase price. It represents the brand, the reputation, and the "special sauce."
But don't get ego-driven here. Owners always think their brand is worth more than it is. Buyers only care about brand to the extent that it drives repeatable, predictable cash flow. If your brand is "famous" but you're losing money, your brand is effectively worthless in a valuation context.
Common Pitfalls to Avoid
- Over-reliance on Rules of Thumb: Don't just use an industry average multiple. Every business has "hair" on it.
- Ignoring Working Capital: A business needs cash to run. If the seller takes every cent out of the bank account on closing day, the buyer has to inject cash just to keep the lights on. That effectively raises the purchase price.
- Forgetting the Taxman: A $10M valuation is great until you realize it's an asset sale and you're getting hit with heavy depreciation recapture taxes. Structure matters as much as the number.
The Strategic Buyer vs. The Financial Buyer
Who you sell to changes the value.
A Financial Buyer (like a private equity search fund) cares about the cash flow. They want a return on their investment. They’ll pay a "market" multiple.
A Strategic Buyer (like a competitor) might pay way more. Why? Synergies. If they buy your company, they can fire your entire accounting department and use theirs. They can sell their products to your customers. To them, your $1M profit might become $2M profit instantly. This is how you get those "crazy" outlier valuations.
Next Steps for an Accurate Valuation
If you are serious about pinning down a number, you can't do it on a napkin.
- Clean up the books: Stop running your personal life through the business for at least two years. You want "clean" financials.
- Get a Quality of Earnings (QofE) report: This is different from an audit. It looks at the sustainability of the earnings.
- Benchmark your KPIs: Compare your margins to the RMA (Risk Management Association) annual statement studies. If your margins are way higher than the industry average, be prepared to explain why they won't revert to the mean.
- Hire a Certified Business Appraiser (CVA or ASA): If this is for a legal reason (divorce, partner buyout, estate taxes), a "guess" won't hold up in court. You need a formal report that follows USPAP standards.
Valuing a private company is part science, part art, and a whole lot of digging through old tax returns. It’s about finding the "truth" hidden in the spreadsheets.