Startup valuations for Private Equity Investment

Business Valuation is a process and a set of procedures used to determine what a business is worth. Business value can be different for business owners and investors. Business valuation is the expected selling price of the Business, the actual value varying, depending on how the valuation is determined.

There are 3 ways to determine the value of the Business:

·         Asset Approach

·         Market Approach

·         Income Approach

Asset Approach:

In this approach, Business valuation is done on the basis of Assets and Liabilities, based on the economic principle of substitution. The challenge in this approach is to decide which Assets and Liabilities to include in the valuation, choosing a standard of measuring the value and then determining the actual values. In determining the value using this method, a monetary value is given to the special products or services of the firm that make the firm unique and gives them an advantage over the competitors. The valuation of assets such as Internally Developed Products, as well as the proprietary ways of doing business are also considered, which is not the case in the “cost-based” Balance Sheet.

Market Approach:

This method values businesses on signs from the market place, based on the economic principle of competition. Quite simply, the value of a business is arrived at, on the basis of the “ready rate” of similar businesses, also known as fair market value. Fair Market Value is the price that a willing buyer will pay, and a willing seller will accept, acting in full knowledge of all the available facts.

Income Approach:

Businesses are valued on the basis of the money-making capabilities, based on the economic principle of expectation. In this method, weightage is given to the expected future income risks. There are 2 ways in which valuation can be done under the Income Approach:

1.      Capitalisation Method:

This method divides the expected income by the expected capitalisation rate. If the capitalisation rate is 20%, the business is worth 5 times its current earnings.

2.      Discounting Method:

The projected business income is projected over a future period of time, and a discount rate reflecting the risk associated with achieving the projections is determined, and value of the business at the end of the projection period is arrived at, called as the terminal business value. The present value of this “Terminal Business Value” is determined by discounting calculations, which is what the Business is worth today. For example, the valuation of "Company X" was done as per the Discounted Cash Flow method, as shown below:

VALUATION OF COMPANY AS PER DISCOUNTED CASH FLOW (DCF) METHOD - values in INR Lacs
“COMPANY X”
Assumptions used in the model:
i.   Discount Rate, r	0.20
ii.  Growth Rate, g	0.02
iii. Illiquidity Discount Rate, i	0.15
Particulars ↓; Year →	2017-18	2018-19	2019-20	2020-21	2021-22
Profit Before Tax	380.00	460.00	850.00	1,200.00	1,400.00
Horizon Value as computed based on Cash Flow					3,996.30
Discount Factor	0.83333	0.69444	0.57870	0.48225	0.40188
Discounted Cash Flow	140.28	136.57	223.77	272.47	1,894.70
Illiquidity Discount	21.04	20.49	33.56	40.87	284.21
Gross Discounted Value of the Company					1,610.50

Thank you for reading. Connect with us on support@msmemitra.com for valuation of your Business.

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The team at MSMEmitra.com, with a combined experience of over 60 years in Credit Reporting, Due Diligence, Banking (MSME Funding segment), and Financial Consultancy, provides Financial Consultancy to MSMEs and Start-ups which do not have a CFO or an internal Finance team.

Disclaimer:

This write-up has been collated from various publicly available materials and secondary data, and www.msmemitra.com does not have any copyrights over the content or guarantee its accuracy.