Valuing a Startup using the EBITDA and DCF methods

Valuing a startup can be a complicated process, which is best achieved through a dynamic solution. It calls for several elements to be taken into account. There are several methods that can be used to enhance the quality of the valuation of a company. EBITDA and DCF are two such methods.

EBITDA method

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the cash flow generated by the company’s main activity. As a result, the EBITDA is a reliable way to measure a company’s performance.

A positive EBITDA bodes well for company since it is a clear indication that the company is profitable at an operating level; it sells its products/services for more than they cost to produce/provide. In contrast, a negative EBITDA means that the company sells their products for less than what they cost to produce.

It follows, therefore, that the EBITDA paints an accurate picture of the company’s situation, since the main criteria considered by investors is that a company can demonstrate a simple, measurable indication of the profitability of an investment (another important consideration is the company’s impact on sustainable development). When we compare the EBITDA to the capital invested, we can make a quick financial diagnosis of the company.

To calculate the EBITDA, three methods can be used. Firstly, we can use the average of the three most recent EBITDA’s of the last 3 financial years, without considering the effect of the age of the data (over time it becomes outdated/unreliable). This is calculated after reclassifying certain elements such as leasing charges or stock options.

The second method makes use of a weighted EBITDA. This involves studying the average economic EBITDA allocated to relevant industries. The EBITDA is calculated before any financial restatement.

The third and final method is the reprocessed EBITDA method. The reprocessed EBITDA is the weighted economic average EBITDA as impacted by financial indebtedness, net cash and claims held by members, whether natural or legal persons. In fact, it is the latter that makes it possible to determine the value of the enterprise through EBITDA.

Note that EBITDA does not take into account the financial and exceptional elements of the company, nor its financing and investment policy.

DCF method

The DCF (Discounted Cash Flow) method involves the calculation of the future income that a company will generate to get an idea of its current value.

Simply put, it is a valuation method used to determine the value of a company based on the cash flow it will generate in future.  The application of this method is therefore a question of estimating the value of future wealth that will be generated by a company.

 Conclusion

Both the EBITDA and DCF methods allow for an accurate, fair valuation of a company’s financial situation. However, proper application of these methods is crucial in order to offer credible proof of the value of the company. Beyond being able to learn about the state of the startup’s financial health, the valuation allows us to prepare for the sale of a company.

When selling a company, it is important to not rely too heavily on the valuation of the startup and its price. The estimated value of a company will not necessarily dictate its selling price. Consequently, we should only proceed with the sale of a company when the market is  favourable, to get a fair price.

A valuation of a company is made by taking into account not only the objective value of the startup (such as its annual accounts and other financial data), but also its intangible value, know-how, performance, customer base as well as its growth potential. Ultimately, the purpose of a valuation is to facilitate the sale or transfer of a business.

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Articles from the same author :  Erwan Coatnoan de Kerdu, Author at Startup Info