By Darin Soat, Updated: Nov 6, 2024
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Figuring out how much a pre-IPO company is worth can make a big difference for your investments. It could mean big profits or major losses. It’s tricky because these private companies don’t often share their financial details. But don’t worry—there are smart ways to figure out their value without needing detailed financial statements. In this guide, we’ll show you exactly how to do that. And if you do get your hands on their financial statements, we’ll also walk you through how to analyze them to make better investment decisions.
Table of Contents
Private companies differ significantly from public companies regarding financial reporting and market liquidity. Public companies must periodically disclose detailed financial and operational information, creating a robust environment for financial information accessibility.
Public companies are required to share a lot of financial information through detailed reports like 10-Q and 10-K forms, as well as during earnings calls. This gives everyone access to extensive financial data. On the other hand, private companies tend to keep their financial details more under wraps, sharing information only with a select group of investors.
Public companies benefit from higher market liquidity, making their stocks easier to buy and sell, which typically has a positive impact on their stock price. Private companies are illiquid, typically demanding a discount on their valuation because it’s harder to buy and sell. A variety of studies place this discount anywhere from 20-50%.
A public company’s market capitalization is a true representation of the market value of the company’s equity at any given point in time. This is different than the Enterprise Value (EV), which is calculated by taking the Market Capitalization, adding all debt, minority interest (a company’s ownership interest in other companies), preferred equity, and subtracting cash—hence why Market Capitalization is specifically called the “market value of equity.” It’s worth mentioning that the valuation methods mentioned above for private companies can also be used for public companies to determine if the market capitalization is over or under-valuing a company.
Without standard financial statements, investors must rely on various qualitative and quantitative factors. These include assessing the addressable market, market growth, and product market fit, to gauge whether the company meets a substantial market need, how it stands against competitors, and how it differentiates itself in the market.
Evaluating whether the market size justifies the the company’s business model is crucial. A large and growing market suggests more potential for revenue and a higher valuation.
Researching historical market growth and projected growth can indicate whether the company is positioned in a growing industry. A simple Google search of “XYZ industry growth” can give you a variety of sources, such as MarketsandMarkets, and they will each provide their estimated industry growth. The figure to measure this is typically called a CAGR, or compounded annual growth rate, and it measures the compounded growth over two periods of time. It’s good to synthesize as many of these as you can to get a “consensus” estimate for what researchers believe the market is going to grow at.
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Does the company meet a substantial need? Are there competitors? How does the startup differentiate itself? Again, use your resources to investigate. If you Google “XYZ company competitor” and find that there are a bunch of companies competing in the space, you may want to see how the company you are looking to evaluate differentiates itself. Another way to look at it is to ask yourself if you would buy this product or service. Is it something that appeals to me or other consumers looking to fill this need?
The stage of the company can indicate risk levels. Early-stage companies are riskier, whereas later-stage companies might demonstrate more stability and market validation. The capital structure and equity valuation at different stages are also crucial in assessing a company’s overall financial health and growth potential.
Assessing the trajectory of fundraising efforts and the quality of these efforts can indicate the company’s credibility and potential. Are the funders well-known with many successful exits? Has the company not raised money in a while? Has the company ever experienced a down round, or lowered its valuation? These factors are vital in understanding the financial health and valuation process.
The experience and track record of the leadership team are significant factors in the company’s potential success. Have members of the leadership team worked in similar industries before? Do they have experience with building companies? Their background can profoundly affect the private company’s growth trajectory and success.
For example, one of the biggest myths is that the top startup founders are young, fresh-out-of-college graduates. In reality, the average age of successful startup founders is 45 years old, according to the Harvard Business Review.
Thinking about how and when a company plans to exit can be crucial for you as an investor. If a company intends to stay private forever, you might wonder what’s in it for you. But if they have plans to go public or be acquired, it can greatly influence their valuation. For instance, if a company is gearing up for an IPO, the valuation is likely to rise, providing potential gains. Similarly, if the company is looking to be acquired, investors usually await details of the acquisition price to assess if the current private share valuation is justified. Have you invested in companies through Linqto, or, maybe you’ve sold your own business? Share your experiences in the comments below.
Have you searched court documents for any litigation involving the company? Perhaps you have been able to find financial statements of private companies within court documents. Does the company have any valuable intangible assets, such as intellectual property that could be incredibly valuable?
Use the internet, do your research, and find out everything you can about a company before investing in it.
Investing in pre-IPO companies can be exciting, but it comes with its own set of challenges, especially when traditional financial statements are hard to come by. However, when financial statements are available, there are a few methods that can be used to value a company. These methods include Discounted Cash Flow (DCF) analysis, Comparable Company Analysis, and Precedent Transaction Analysis, all private in private company valuations.
If you do get your hands on the company’s financial statements, you might wonder how to go about making sense of them. Several methodologies can be utilized including three primary methods for valuing a private company. We’ll help you break these down.
A Discounted Cash Flow analysis involved projecting the company’s future cash flows and discounting them back to the present value using a discount rate. This method highlights the intrinsic value of the company by focusing on future cash flows rather than current operations. It sounds complicated, but thankfully the Corporate Finance Institute offers a great training guide on building your own DCF models.
Imagine forecasting the value of an AI company. You would assess the income statements—from revenue growth to net income projections—over several years, evaluate capital expenditures, and calculate free cash flow to determine a terminal value. These discounted cash flows are then brought to the present value using a discount rate, a crucial component in financial modeling.
This method involves looking at comparable companies within the same industry that are publicly traded and then comparing them to the private company you’re valuing. This relative valuation helps in assessing market value by examining multiples like EV over Revenue or EBITDA, providing a baseline for what the market is willing to pay for similar equity value.
For valuing a private automobile manufacturer, analyze the EV and EBITDA. If EBITDA is negative, a similar analysis can be performed using revenue figures. You would then find the median and average the EV/EBITDA ratios from these comparable companies, apply it to your target investment’s EBITDA, and derive an equity valuation.
This method looks at recent mergers and acquisitions of similar companies, both public and private, to gauge the fair market value of your target investment. This involves detailed research into historical acquisition prices, an effort that extends beyond simple market analysis to include a deep dive into business valuation. Because historical acquisition prices and financial headline numbers are usually not publicly available, you’d have to pay for services like Pitchbook to access it.
In valuing a fintech company, review recent sales of comparable companies, noting their sale price (Enterprise Value) and EBITDA at the time of sale. Applying the EV/EBITDA multiple from these transactions to the company in question provides an estimate of fair market value.
A comprehensive checklist will help investors systematically assess various aspects of a pre-IPO company before making investment decisions. This checklist should include:
Valuing private companies, especially those without readily available financial statements, calls for a more holistic approach beyond just the numbers. Unlike public companies that offer a wealth of data, assessing a private company’s worth often hinges on alternative indicators. For instance, you would look at the market potential and how well the company can meet that demand. What makes the company stand out from its competitors? Is the leadership team effective and guiding the company in the right direction? Also, consider the quality of its investors since experienced investors usually signal a strong future outlook. Whether you’re a finance professional or an accredited investor, doing your homework is crucial. Dive deep into your research, stay informed about industry trends, and keep a close eye on company news. This comprehensive approach will help you better understand a private company’s real value.
Darin Soat
Darin Soat is Linqto's Head of Community and Education. Prior to joining Linqto, he spent half a decade in investment banking doing mergers and acquisitions in the healthcare and technology industries, most recently in San Francisco for Cain Brothers. While in investment banking, Darin held his FINRA Series 63 & 79 licenses. He is based in Los Angeles.
2 Comments
Thanks for the article Darin which was very timely as it starts to address a question I ask myself about how to value a pre-IPO company as part of due diligence prior to considering an investment.
It would be super helpful if you could add a couple of examples of the valuation of investments offered by Linqto. (While I appreciate that it would be a lot of work, it would be a real service to have a valuation range for each, or at least a subset of, the pre-IPO company you offer!)
Hi David – thanks for the feedback as well as the suggestion.
If you look at a company with shares available, you’ll see the “Implied Valuation” based on the price. Scrolling down, you can see the valuation at the prior fundraising round and compare the two. The Implied Valuation is the closest thing you’ll find to a spot valuation, basically the price you can invest in a given company at on Linqto. For example, if you see that a company you’re interested in investing into raised a round valuing it at $5B in 2023, but Linqto’s Implied Valuation is $6B, the IV is suggesting it’s worth more than that last fundraising round. These valuations are dependent on the valuation we (Linqto) are able to acquire the shares at. So, if they’re more expensive than the prior fundraising round, that’s a reflection of what the market for those shares was asking for them.
All that said, the job of the investor is to determine how that implied valuation fits into your investing goals. For example, if it’s a discount to the prior round, is it a “value” investment or should it be trading for less? If it’s at a premium to the prior round, is it overpriced, or maybe that valuation makes sense? To summarize this point, just because it trades at a discount or premium to the prior round has no absolute determination on whether or not it’s a good fit for your portfolio. It’s just one heuristic that you can use.
Now, I think your suggestion is like what equity analysts would do for public companies, but instead we do it for private companies. They basically look at the stock price for public companies, assign a buy, hold, or sell rating and a target price, which helps investors build their portfolios. I really like that idea and will talk to the team about exploring it more.
Again, thanks for your feedback, and hope this helps!
– Darin