A friend of mine was once asked how much his house was worth at dinner. He said “I guess whatever someone will pay for it.” I was pretty young at the time and don’t think I fully appreciated the wisdom of the comment. These days, I get a report from Zillow once a week that shows me how much they think my house is worth. And they’re pretty close to what I see houses in the neighborhood good for. But ultimately, the house is worth what someone would be willing to pay to buy it. If sold, I would walk away with the sale price of the asset (the house) minus any liabilities (the mortgage).
Companies are similar, although there are a few different methodologies we can use to get a good idea of what a startup or business is actually worth. Traditionally these would mainly be the assets minus liabilities, a comparable look at other similar businesses, the income of the business, and a replacement value. The valuation then becomes the basis for any investments or capitalization done to accelerate the growth of the company or to buy out any partners if a principal exits.
Valuation can be one of the more contentious aspects of a company. When money is involved, things often get weird. So it’s often best to let a third party handle doing so. Once a company goes public, the valuation is easy. The market sets the value based on the outstanding shares and the price per share. But let’s look at other ways to do a valuation in a pre-IPO scenario.
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