What is a reasonable and fair value of your company?

Most entrepreneurs or founders who watch the stock market know that a company's Enterprise Value = Market Cap + Total Debt-Cash. But how do you know what a fair and reasonable value might be before an initial public offering (IPO)? What is a reasonable and fair value of your company?

One important way companies are valued, or their market worth is evaluated, is in terms of their earning potential based on the industry they compete within. Companies that successfully file patents and earn royalties can be worth as much as 100 times annual EBITA or earnings before taxes. I ran a marketing agency in San Diego in the 1990’s that brought in $3MM annually but only returned $400,000 to the bottom line. It was heavily dependent on billing hours for 25+ clients who could fire our firm with 60 days’ notice. That firm did not even net 1X revenue or $3MM as a sales price because of the transitory nature of its client base and the high cost of the human capital doing the client’s work.

Often financial earning power information can be measured by a price to earnings ratio. This is Price/Earnings Ratio = Equity Value ÷ Net Income. This equation can be very useful for those of you whose companies are public or for investors to evaluate the earning power of that firm. If someone is willing to buy your company or makes a bona fide offer, then that is another kind of “strategic” valuation. Another kind of company valuation can be done by business consultants that claim to help you package your company for a sale. Those consultants will give you all kinds of equations, ratios, and formulas to determine what's your company might be worth in a potential sale.

Private equity and venture capitalists have their own formulas and financial due diligence required to make a valuation estimate. But all of these are just that, an estimate. If you're thinking of offering options for your top employees to buy into (ownership position in your private company to incentivize or retain them), think carefully about how you go about determining the valuation before you set option prices or go to your law firm and board to make it official.

Let’s figure out the following to see if this equation can be helpful to private companies looking to set an evaluation. Enterprise Value/Revenue = Enterprise Value ÷ LTM. LTM stands for “Last Twelve Months” and is similar in meaning to what finance professionals’ term TTM, or Trailing Twelve Months. LTM Revenue is often used in the world of finance as a measurement of a company’s financial health. If your company reports or calculates the revenue figures for the “past 12 months, then you can get at a pretty reliable valuation. LTM or TTM Revenue shows a company’s performance in the past year rather than just seeing the quarterly figures and adjusting it for the full year. Because LTM is so powerful and relevant to most firms value, a high value LTM translate into a much higher valuation in a sale. With these starting tools, I hope you can get at what might be the value of your firm today. ?However, only a current stock price or competitive offer to purchase your business are truly bona fide valuations.?