What’s My Company Worth?

If you’re reading this article, you probably just Googled or asked an AI chatbot something like that, read the feedback, scratched your head, and then wondered how to make sense of the answer. That’s because it’s a loaded question. There are many reasons to seek a valuation and many methods to value a company. This article explains some of the most common reasons and methods.

The Startup

At a company’s launch, no valuation is needed. If it’s a corporation, the company sets a default minimal price for its authorized shares, which is usually a fraction of a penny. If it’s a limited liability company, the company sets no price at all. Off it goes and starts doing business. It creates a minimum viable product, tests it in the marketplace, gets some customers, makes some money, and then boom, it hits its first point where it needs a valuation. This is usually one of two situations. Either it needs to incentivize key employees or contractors with equity, or it needs to raise capital from investors.

Incentivizing Key Employees or Contractors

To incentivize key employees or contractors, the company likely won’t have enough cash to pay top compensation, so it’ll offer equity or options. The best way to do this is usually through an equity incentive plan (aka stock option plan). The most common types of awards through equity incentive plans are restricted stock (common stock with some restrictions), incentive stock options (ISOs), and nonqualified stock options (NSOs or NQSOs). 

The company will need to decide what its common stock is worth so that it can price the awards correctly. It’s ultimately up to the board of directors to determine that price, but unless the company is brand new, the best practice is to get a 409A valuation. There are a lot of service providers offering these valuations, so they’re not hard to get, and they’re typically not very expensive, especially for young companies without much operating history. If that’s the case, the valuation typically comes back as some small number – more than a fraction of a penny, but not much more than a handful of dollars.

Raising Capital From Investors

To raise capital from investors, the company sometimes will need to determine its valuation. Companies usually raise capital in one of two ways – either in unpriced rounds or in priced rounds. Unpriced rounds mean there is no price associated with the investment being purchased. These rounds usually involve convertible notes or SAFEs. Priced rounds involve the sale of preferred stock at an exact price.

In unpriced rounds, there is no valuation conducted. The company has to convince investors that it might be worth approximately some value now or in the very near future. Taking the example of a SAFE investment with a valuation cap, the company picks a valuation cap that it thinks might be around what the company is worth in the very near future, and then pitches investors the idea of placing their bets on the company now before the price goes up. To be perfectly honest, the valuation cap number is often just a best guess by the company about its worth.

In priced rounds, a valuation is determined. It’s usually just the agreed upon price that’s negotiated between the company and the lead investor in the priced round. Priced rounds involve the sale of preferred shares, so the price of those shares will be worth more than the price of the company’s common stock (since the preferred stock has more benefits associated with it), and at a minimum it’s understood that the price of the shares must therefore be some number greater than the common stock. From there, companies typically use their best guess, pitch investors, and see how they react. Once the companies get enough interest from investors, the price is agreed upon and the round gets funded and closed.

The Successful Company

Companies that have grown past the startup phase typically run into valuation questions when they hire, promote, or there is a generational change.

If the company is fast-growth – a company aiming to be the next Google, Facebook, Nvidia, etc. – that equity is often offered to them through the company’s equity incentive plan, and so the company can rely on its 409A valuation. 

If the company is a main street business – one of the countless US small businesses just trying to be profitable and grow slowly – owners typically have no idea what their company is worth, and since those companies don’t need to incentive a lot of employees and contractors at once, they rarely have equity incentive plans in place and so don’t have or need a 409A valuation. To determine the value, owners typically rely either their own best judgment, business valuation experts, or simply negotiate an agreed upon valuation from scratch with the people they’re offering equity to. There is no right answer here, but the valuation has to be something that both sides agree is fair and manageable. Often the buyers of the equity will not pay for the entire amount up front; they’ll pay none or some up front and pay for the rest with a promissory note.

The Exit

A merger or acquisition is the end of the road for a company. Some owners exit for good reasons (they get a great price from a worthwhile buyer), some exit for bad reasons (the company is failing and is sold for pennies on the dollar), and sometimes the reason is somewhere in between. 

The valuation is the agreed upon price between the seller and buyer, and that’s it, subject to any further attempts by the buyer to drive the price down during the buyer’s due diligence. Sellers typically know what they’d be willing to sell the business for, and then they rely on buyers to make a reasonable offer. Sometimes buyers openly market their companies for sale, whether formally through a business broker, or informally through their network or trusted advisors, like business exit planners.

Outside valuations are not common for mergers and acquisitions, and getting an outside valuation in advance of an anticipated sale is usually not a good idea. If the valuation comes back at a price lower than the seller’s ideal price, then the buyer will want to know that price and it will use it against the seller during negotiations.

Whether in the startup, growth, or exit phase, owners want to know the value of what they built. The answer completely depends on the context – the stage the business is in, who the audience is, and why that person is asking – and valuation will be different depending on all of those factors.