Snap Inc. signage is displayed outside Morgan Stanley’s building in New York on Thursday, February 16, 2017. (Photographer: Michael Nagle/Bloomberg)

Snap Inc., the company behind Snapchat was given a valuation at $25 bn, which is at least twice the value given to Facebook, and four times as much as Twitter during the time of their IPO. Ever wondered how a disappearing messaging tech-company got valued at such a high number? We consulted with our valuation consultant in order to get a better understanding of business valuation methods. Business Valuation is a process of determining the value of a business for a variety of reasons, which may include buying or selling of business, raising additional funding, settlement of business disputes etc.

There is no hard and fast rule regarding Business Valuation. Valuation is a relative concept. Though valuation is carried out in a scientific manner, it only provides a suggestive figure. True value of a business is what someone is willing to pay for it. A business, which seems of a lesser value to one, may prove to be of a significant value to another or vice versa.

Valuation is affected by different circumstances surrounding the valuation. E.g. an ongoing business will be valued more than a similar business, which is in the process of winding up. Valuation focus may be more on the valuation of tangible assets in case of asset rich business like property/real estate business while main focus on valuation of a service industry will be on valuation of its future profitability.

Likewise, valuation of start-ups basically depends upon the willingness of the investors or venture capital firms to pay for their shares, which in turn depends on the investor’s interest in the business. It also provides a basic idea about the minimum amount that can logically be expected from the investor and provide the investee a starting point to initiate the conversation.

Three of the most common methods of valuation are Asset Based Valuation Method, Market Based Valuation Method & Discounted Cash Flow Method.  The method of valuation may differ on a case-to-case basis and needs investor and investee’s judgment.

Asset Based Valuation Method

Asset based valuation method focuses on Net Asset Value of a business inclusive of only tangible assets currently held by the business and does not take into account of future earnings. This method is relevant if you have a stable, asset rich business such as real estate or a manufacturing business.

In general, the discounted cash flows of a well-performing company exceed this value. However, this method of valuation will have an edge over other methods for companies which are not performing well but own significantly high value tangible assets.

Market Based Valuation Method

Market value is a price which the business would fetch in the marketplace. Under this method, value is determined by multiplying the number of its outstanding shares by the current market share price or by studying the prices people pay for similar businesses.

Market value is determined by the multiples accorded to companies such as P/E ratio and Enterprise value to EBITDA.

This method proves to be of a little significance to unquoted businesses since information relating to market share price, P/E ratio, Enterprise value to EBITDA ratio are very difficult to obtain for such businesses.   

Discounted Cash Flow Method

This method is used for mature businesses with cash-generating history and is the most technical way of valuing a business.

This method takes cash flow history, future cash flows, growth rate, and cost of capital into consideration. Expected future free cash flows are discounted by an opportunity cost of capital, which takes into account the risk and the time value of the cash flows, to arrive at the present value of the business.

Contributed by : CA Sudarshan Adhikari, Nishu Baral