Valuation . . .

refers to the value an arms-length purchaser would pay for all of the outstanding stock and stock rights of a company. In a public company, valuation is also referred to as a company’s market capitalization or market cap, which is the value generated by multiplying the company’s outstanding stock by its trading value. For example, a company with 10 million outstanding shares trading at $22.50 would have a valuation or market cap equal to $225 million (10 million shares multiplied by $22.50).

Determining the valuation, or value, of a privately held company is more difficult than with a publicly traded company because of the absence of an active market in private company securities. Methods frequently used to value growing private companies include the discounted cash flow method and the market price method, discussed elsewhere in this book.

As a short-hand method, entrepreneurs and investors frequently refer to the valuation of a venture capital backed company by reference to the amount of money the venture investor paid for the percentage of ownership acquired in the investment. For example, when a venture capitalist purchases 25% of a company for $1 million, the parties may refer to the company’s valuation before funding as being $4 million, which is the value determined by dividing the amount invested by the percentage purchased. The post-money valuation is frequently determined by adding the amount invested to the pre-money valuation, in this adding $1 million to $4 million to get a $5 million post-money valuation. See: Discounted Cash Flow, Market Price Method, Post-Money Valuation, Pre-Money Valuation, Pricing.