What it means
Three broad approaches cover most valuations. The income approach values future cash flows discounted back to today, the market approach applies multiples paid for comparable businesses, and the asset approach adds up what the underlying assets would fetch less the liabilities owed.
Which approach fits depends on the business. A stable, cash-generative company suits a discounted cash flow or an earnings multiple, a property holding company suits an asset-based view, and an early-stage business with no profits is usually valued on revenue multiples or on what investors will pay for a share of the opportunity.
Two words cause most of the confusion in valuation conversations. Enterprise value is what the whole operating business is worth regardless of how it is financed, while equity value is what the owners' shares are worth after deducting debt and adding back surplus cash.
Valuation matters at very specific moments: raising investment, selling or buying a business, settling a shareholder exit, granting share options, or agreeing a figure for tax or a divorce settlement. The purpose shapes the number, because a valuation for a forced sale and one for a strategic buyer are answering different questions.
The drivers are more predictable than the outputs. Growth rate, margin quality, customer concentration, recurring revenue, dependence on the founder and the strength of the management team explain most of the difference between a business valued at four times earnings and one valued at eight.
The final nuance is that a valuation is not a price. Price is what an actual buyer pays after negotiation, competitive tension and due diligence findings, and it can sit well above or below any careful valuation prepared beforehand.
In practice
Real-world examples
Example 1
A founder preparing to hand a print business to her children commissions a valuation to set a fair price between siblings. The valuer uses an asset-based approach because the company's value sits largely in its presses and freehold rather than in its modest profits.
Example 2
A startup raises $2,000,000 at an $8,000,000 pre-money valuation, giving a post-money valuation of $10,000,000. The investor therefore holds $2,000,000 / $10,000,000 = 20% of the company immediately after the round closes.
Example 3
A private equity firm values a services business at 7 times EBITDA but reduces its offer after due diligence shows 45% of revenue comes from a single client. The valuation model did not change; the multiple applied to it did.
Think of it
Think of valuation like appraising a house. Just as a real estate agent evaluates a house to determine its market price, a business valuation assesses all aspects of a company to determine its financial worth.
Formula
Calculation
A common market-based approach is: Enterprise Value = EBITDA x Earnings Multiple, then Equity Value = Enterprise Value - Debt + Cash.
A specialist components manufacturer generates EBITDA of $4,000,000. Recent sales of similar businesses have been priced at around 6.5 times EBITDA, giving an enterprise value of $4,000,000 x 6.5 = $26,000,000. The company carries $7,000,000 of bank debt and holds $2,000,000 of surplus cash, so equity value is $26,000,000 - $7,000,000 + $2,000,000 = $21,000,000. Spread across 3,000,000 shares in issue, that is $21,000,000 / 3,000,000 = $7.00 per share.Case study
Seen in the real world
Ashfield Coatings is a fictional industrial paint applicator used here as an illustrative example. Its owner expected an offer around $12,000,000 based on a conversation at a trade event, and was disappointed when the first serious bidder valued the business at 5 times its $1,800,000 EBITDA, or $9,000,000 enterprise value. After deducting net debt of $1,500,000, the equity on offer was $7,500,000.
The buyer explained the discount rather than hiding it. Two customers accounted for 60% of revenue, the owner personally held the technical accreditation the business traded on, and there were no written contracts beyond rolling purchase orders.
Over the following two years the owner signed three-year agreements with both major customers, put two supervisors through the accreditation, and won enough new work to bring the largest customer down to 28% of revenue. The business was eventually sold at 6.5 times an EBITDA of $2,100,000, an enterprise value of $13,650,000, showing that valuation is something a management team can influence rather than merely receive.
Watch out
Common mistakes
- Quoting a valuation without saying whether it is enterprise value or equity value, which can misstate what an owner actually receives by the whole amount of the debt.
- Applying a multiple heard about another company without adjusting for size, growth, customer concentration and how much the business depends on its owner.
- Treating a funding round valuation as the amount of cash the founders could realise, when it reflects a small parcel of shares bought with rights ordinary shareholders do not have.
Questions
People also ask
What is the difference between valuation and price?
Valuation is an informed estimate of worth, while price is what an actual buyer and seller agree after negotiation and due diligence.
Which valuation method is most reliable?
None on its own, which is why practitioners usually triangulate two or three approaches and explain why the answers differ.
Why do buyers pay different prices for the same business?
Because a strategic buyer expecting cost savings or new revenue can justify more than a financial buyer relying on the business as it stands.