If you want to work in investment banking, you need to master the art of valuation. Valuation is the process of estimating the worth of a company, a project, or an asset based on various methods and assumptions. In this article, you will learn about the different IB valuation techniques and how to compare them.
The market approach is based on the idea that the value of a company or an asset can be derived from the prices of comparable companies or assets in the market. This approach can be divided into two methods: the comparable company analysis (CCA) and the precedent transaction analysis (PTA). The CCA uses the multiples of similar publicly traded companies to value the target company, while the PTA uses the multiples of similar transactions that occurred in the past to value the target company. The market approach is useful for valuing companies or assets that have a lot of peers or deals in the market, but it can be affected by market conditions, timing, and selection bias.
Simply, the market approach is used to value companies based on the multiples of similar publicly listed companies and multiples of previously completed transactions. The great thing about this approach is that its simple, quick and more or less accurate. However, during volatile trading periods, this might not be the best approach.
In my experience as a student, I use Comparable Company Analysis (CCA) as well as NAV-Net Asset Value to value various asset classes and compare accordingly to determine the price of the equity.
t's essential to exercise caution in the selection of comparable companies or deals, considering factors such as industry dynamics and financial metrics. Market conditions and timing should be carefully weighed, and a systematic approach should be adopted to minimize selection bias, ensuring a more accurate valuation.
Market, Income, and Asset Approach - each of them has its merits as well as limitations. No one single approach can fit all valuations. Depending on the subject company being valued, it's industry and life cycle stage, its competitors, market, and economic conditions, different approaches can offer different advantages. What a good valuation specialist bears in mind is that it is not just the technique, but the data behind that makes a good valuation. I tend to use all three approaches when applicable. And if the conclusions from any one approach differ significantly, one must be able to explain why by not just looking at the numbers, but at the economics behind.
1. Comparable Company Analysis (CCA) / Comparable Company Valuation (CCV): ? Description: Compares the target company to other similar publicly traded companies. ? Methodology: Ratios such as Price-to-Earnings (P/E), Enterprise Value-to-EBITDA, or Price-to-Book are calculated for the comparable companies. These ratios are then applied to the target company to estimate its value. 2. Precedent Transaction Analysis (PTA) / Precedent Transactions Valuation (PTV): ? Description: Examines the valuation multiples of past M&A transactions in the same industry or sector. ? Methodology: Similar to CCA, but instead of comparing with current market multiples, analysts use multiples from historical transactions to estimate the target company's value.
The income approach is based on the idea that the value of a company or an asset can be derived from the present value of its future cash flows. This approach can be divided into two methods: the discounted cash flow analysis (DCF) and the leveraged buyout analysis (LBO). The DCF uses the free cash flows of the company or the asset and discounts them by a weighted average cost of capital (WACC) to obtain the enterprise value, while the LBO uses the cash flows available to debt and equity holders and discounts them by a required rate of return to obtain the equity value. The income approach is useful for valuing companies or assets that have stable and predictable cash flows, but it can be sensitive to assumptions, projections, and discount rates.
Interestingly, valuing startups using the income approach differs from traditional methods. Startups lack historical data, making cash flow projections crucial. Factors like growth potential, innovation, and scalability shape their valuation. An example is WhatsApp, acquired by Facebook for $19 billion despite minimal revenue. The income approach for startups relies on forward-looking projections and carries inherent uncertainty, distinct from traditional valuations based on historical financials.
This concept is the ultimate key to all valuation. However, the way it gets executed is hard. How do we know next 20 yaers of cash flow. Often this approach is used by bankers to generate more fees. DCF barely works with accuracy, and no one can easily use it. However, DCF works for a transitionary period where using a multiple on a normalized earnigns figure (EBTIDA, EBIT, NI or FCF) is not appropriate. For first few years of rapid growth in an organization, DCF should be utilized for a limited time to get to a point where a multiple approach makes more sense.
The most important factor to consider when valuing a business is its future cash flows. This is because the value of a business is ultimately determined by its ability to generate cash flows for its owners. Other factors that may impact the value of a business include its assets, liabilities, risk profile, and industry trends. However, the future cash flows of the business should be the primary focus of any valuation analysis.
The income approach values startups with intangible assets, as intangibles lack market comparables. Discounted cash flow (DCF) and leveraged buyout (LBO) models estimate the present value of expected future revenues to value intangibles. For media startups(in my expreince), DCF values subscriber bases, content libraries, platforms by projecting subscriber, advertising, licensing revenues. Growth assumptions, churn forecasts, costs, discount rates must be carefully considered. DCF captures high growth potential but also risks. Though income approach requires projections, for startups with intangible assets like content and audience, DCF and LBO are often more appropriate than market multiples.
The asset approach is based on the idea that the value of a company or an asset can be derived from the sum of its individual assets and liabilities. This approach can be divided into two methods: the book value method and the liquidation value method. The book value method uses the accounting values of the assets and liabilities on the balance sheet to obtain the equity value, while the liquidation value method uses the net proceeds from selling the assets and paying off the liabilities to obtain the equity value. The asset approach is useful for valuing companies or assets that have low earnings or growth potential, but it can be outdated, incomplete, or subjective.
Asset Approach in startups - Valuing startups with the asset approach can be challenging due to their intangible assets. This approach might undervalue startups with substantial intellectual property. Startups are often valued based on their growth potential, so the asset approach may not be as relevant. However, it can be useful in specific situations, like when a startup is transitioning or facing financial distress. A well-rounded startup valuation strategy should incorporate various methods, including income and market approaches, to provide a more accurate picture of their value.
I believe the Asset Approach can serve as an additional tool to Income and Market approaches for startup valuations. It reflects the investments made into development of the product (which is frequently the main asset of the startup) and can provide an assessment of its potential.
If someone cannot get a reasonable market value but can sell some, things like land, private equity stake, patents are hard to come up with acceptable values - sell a small piece of it and find out. Even listed options, sell or buy 2 contacts to see where true demand is before making a sizable directional bet.
The asset valuation approach, using book value or liquidation value, has limited applicability for startups. Startups derive value from intangible assets and growth potential not captured on balance sheets. Book value misses strategic worth of intellectual property, technology, talent, and brand. Liquidation value is even less relevant since startups have minimal hard assets. Startups' equity value stems from innovation, human capital, and scaling potential, best valued through forward-looking discounted cash flows rather than static balance sheet items. The asset approach rarely matches the strategic value of startups' intangible growth opportunities.
There is no single best valuation technique for every situation. Each technique has its own advantages and disadvantages, and the choice depends on the purpose, the availability of data, and the industry characteristics. To compare them, you need to understand the underlying assumptions, inputs, outputs, and limitations of each technique, and use multiple techniques to cross-check and validate your results. You also need to consider the market sentiment, the competitive landscape, and the strategic fit of the company or the asset you are valuing.
The best valuation technique to use depends on the specific circumstances. For example, if the company being valued is a publicly traded company with a long track record of financial performance, then the DCF method is likely to be the most accurate valuation technique. However, if the company being valued is a private company or a start-up company with limited financial data, then the CCA or PTA methods may be more appropriate. In many cases, investment bankers will use a combination of valuation techniques to get a more complete picture of the value of a business. For example, they may use the DCF method as their primary valuation technique, but also supplement their analysis with CCA and PTA data.
From my experience working in this field, I've learned that the value of an asset lies in the eyes of the beholder. Strategic investors consistently outcompete the bidding process because they typically incorporate synergies into their valuations, which can be challenging to observe from an external perspective. On the other hand, financial investors often rely on traditional valuation methods, with SME valuations leaning more towards using multiples and large enterprises favoring forms of discounted cash flows, such as the sum-of-the-parts approach.
For startups, discounted cash flow models best capture the value of high-growth potential and intangible assets not reflected in comparative market multiples or balance sheets. But no single valuation approach fits every situation. The choice depends on data availability, industry dynamics, company stage, and purpose. Using multiple techniques helps validate assumptions. Beyond quantitative models, qualitative factors like market sentiment, competition, and strategic positioning must be weighed. Startup valuations benefit from blended methodologies accounting for hard-to-quantify innovation and human capital assets. Thoughtful triangulation provides perspective, but ultimately startup valuations remain more art than science.
The thing that I find most useful is sitting down with the CEO. And sometimes the CFO because the CFO does all the work. Or IR, the abused stepchild of the office. Let them pitch.
In addition to the main valuation techniques discussed above, there are a number of other factors that you may want to consider when valuing a company, such as Quality of management, Strength of the company's brand, Company culture Competitive landscape, Regulatory environment, Economic outlook, IPO market conditions