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:
Flow, Market Price Method,
Valuation, Pre-Money Valuation,