Valuation is what a business is worth, as in “this company’s valuation is $10 million.” This would mean that a company is valued at $10 million, or worth $10 million.
The term is used for discussions of sale or purchase of a company; it’s valuation is the price of a share times the number of shares outstanding, and the price of a share is the total valuation divided by the number of shares outstanding. And it’s also used in the context of angel investment and venture capital, to establish a value used to determine how much ownership of a business the investors get in exchange for their investment.
Some of the different startup valuation methods consider:
- Rate of return
- Timing and form of return
- Amount of control desired
- Acceptable level of risk
- Perception of risk
- Comparable investments elsewhere
With startups and investors, valuation is negotiated. The key factors are how much money the startup founders can get from investors, for how much ownership of their business. Investors want more equity (i.e. ownership, or shares) for less money and startup founders want more money for less ownership. The most powerful tool on either side is the simple word “no.”
Standard business valuation methods may include:
- Asset-based valuation: the business is worth the sum of its assets. Not a popular valuation method for new businesses, because their future should be worth a lot more than their assets.
- Book value: the book value of a company is the calculation of assets less liabilities.
- Adjusted book value: this variation adjusts the assets – liabilities calculation for real value of assets, distinguished from the accounting value.
- Liquidation value: what a business would yield in real money if its assets were liquidated.
- Replacement value: what it would cost to replace the business if the replacement started from scratch.
- Earnings Based Valuations: this is by far the most popular method for new businesses; they are valued based on future earnings.
Valuation is also important for tax reporting. Some tax-related events such as sale, purchase or gifting of shares of a company will be taxed depending on valuation.
The term is used less in discussions of major publicly traded companies, but it is essentially the same as market cap or market capitalization.
Used as a verb, valuation is the process of determining what the business’ valuation. In this context, a valuation is like an audit, and a valuation expert is a CPA or analyst who does valuations. Some CPAs are certified as valuation experts, which means the IRS is more likely to accept their valuation as part of a transaction related to taxes.
Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry.
