What kind of valuation do you need?

Someone recently asked about the cost for a valuation. As with many questions we hear, this one also has to be answered with a question: why do you need a valuation? And that, in turn, is really better framed as this question: what are you trying to do, and let us give you some guidance on how to get there. (This approach falls into our intentions-based guidance theme.)

Here’s the original question:

Has anyone used companies in the business of valuing companies? What are the typical fees and how good a job do they do for small (less than a million) companies?

Here’s our answer:

We’ve done valuations for all sizes of companies for all types of reasons. The comment below asking about the purpose is the right starting point. The “amount” of valuation work you need depends on the purpose. For example, if you are pitching the company to sell it, you will be putting all the financial information together and forecasts and then just need a typical valuation (where possible, the three-legged stool: comparable companies, comparable transactions, DCF) that is aggressive enough to give you a reasonable shot at not leaving money on the table.

On the other hand, if you are doing a valuation for estate planning purposes, there are specific IRS rules/policies that you will want to have taken into account.

And if you just want to know what it’s worth, that’s a different story entirely.

The last category that I want to highlight is a special 409A valuation, which is often sought by early stage companies to immunize their employees from later penalties if stock options are granted at a price below FMV. We’ve seen valuations to satisfy the law’s requirements ranging from a few thousand dollars to $20-25k depending on how many series of preferred stock are on the cap table.

$8-10k should get you a very well-reasoned valuation IF you have your financials and forecasts in standard form and documented. What you don’t need, and almost certainly don’t want, is just a math exercise that takes a set of projections and figures out the DCF at some 25% discount rate. That’s useless to you; what you want is a business model in standard (and by standard I mean bulge-bracket I-bank/private equity firm standard, not I-found-a-free-template-on-Office-Live standard) form, with documented assumptions, that drives a set of projections that can be used as the basis for a valuation. We often end up starting a valuation project that turns into a business model project (which culminates in a valuation).

Why do I stress this? Because all savvy investors and buyers know that it’s garbage in, garbage out. If you have a well-constructed model, it’s easier to identify overly aggressive assumptions and arrive at an appropriate valuation.

Edited 4/2012.