How private companies are valued

Why there is no single right answer

A listed company has a price because thousands of people trade its shares continuously. A private company has no such mechanism. Its shares are illiquid, its financials are not public, and there may be only a handful of plausible buyers on earth.

So valuation becomes an exercise in constructing a defensible estimate of what those buyers would pay. Two competent advisers, working honestly from the same accounts, can reach numbers that differ by fifty percent — not because one is wrong, but because they have made different assumptions about growth, risk and who the buyer is.

This is the single most useful thing for an owner to understand before entering a process. A valuation is a position in a negotiation, supported by evidence. Treating it as a fact to be discovered leads to disappointment; treating it as a case to be built leads to preparation.

The three families of method

Market-based. What have similar businesses sold for? Apply the multiple those transactions implied to your own earnings. Simple, intuitive, and only as good as the comparability of the comparables.

Income-based. What cash will this business generate in future, and what is that stream worth today? Discounted cash flow is the main technique. Rigorous in structure and extremely sensitive to its assumptions.

Asset-based. What would it cost to replace what the business owns, or what would the assets fetch if sold? Relevant for asset-heavy businesses and for a company worth less as a going concern than in pieces — which is itself an important finding.

In practice a credible valuation triangulates. If a multiple-based figure and a cash-flow-based figure land close together, confidence rises. If they diverge sharply, that divergence is the interesting information — it usually means the business's recent earnings and its future prospects tell different stories. DCF versus comparables covers how each behaves.

What buyers are actually pricing

Buyers do not really buy earnings. They buy the probability that earnings continue.

That distinction explains almost every valuation adjustment an owner finds surprising. Two businesses each making R10m a year can be worth very different amounts depending on how confidently a buyer can project the eleventh year: customer concentration, contract length, recurring versus one-off revenue, dependence on a single person, exposure to a single regulation.

It also explains why the same business is worth different amounts to different buyers. A trade buyer who can remove duplicated overheads or sell your product through their distribution is buying something more valuable than the standalone business. A financial buyer is buying the business as it is. The gap between those two numbers is not negotiating room — it is a genuine difference in what is being acquired.

Normalising the earnings, which is where the work is

Before any multiple is applied, reported profit is adjusted to reflect what the business genuinely earns under normal ownership. In owner-managed companies this step frequently moves the valuation more than the multiple does.

Typical adjustments run in both directions. Owner remuneration is restated to a market salary for the role — upward if the owner underpaid themselves, downward if they did not. Personal expenses running through the business are removed. One-off items — a legal settlement, an insurance recovery, a single exceptional contract — are stripped out. Related-party transactions such as rent paid to an entity the owner controls are restated to market terms. And under-investment is corrected: a business that has deferred maintenance or capital expenditure looks more profitable than it sustainably is.

Every one of these will be found in diligence. Presenting them yourself, documented, is treated as competence. Having a buyer discover them is treated as a reason to re-open price.

Why the number moves after agreement

Owners are often blindsided when a headline price and the money actually received differ. Two mechanisms explain most of it.

Enterprise value versus equity value. A price is usually quoted as enterprise value — the value of the business operations, debt-free and cash-free. What a seller receives is equity value: enterprise value, less debt, plus surplus cash, adjusted for working capital. A business sold at an enterprise value of R100m carrying R25m of debt delivers roughly R75m to shareholders. Nothing improper has occurred; the two numbers simply measure different things.

Working capital adjustment. Deals normally assume a normal level of working capital passes with the business. If it is lower at completion than the agreed benchmark, the price is reduced. Sellers who aggressively collect debtors and stretch creditors before completion frequently find the benefit clawed straight back.

What an owner can actually change

Market multiples are not within your control. Several things that move the number are.

Reduce customer concentration. Convert one-off revenue to contracted or recurring revenue. Document what lives in your head. Build a management team that can operate without you — see the founder-dependence discount. Get the accounts audited and clean. Resolve contingent liabilities before someone else finds them.

None of these are quick, which is the argument for starting well before a sale is contemplated. A business prepared over two years typically transacts at a materially better number than the same business taken to market cold, and the gap is usually larger than any negotiation could recover. For a South African owner working through the practical steps, business valuation in South Africa and growth-stage valuation methods in Africa take it further.