In a manner of metaphor, valuing a company is like valuing a middle aged rock star. What instruments do they own? What songs do they own the copyrights on? And can they fill a stadium of fans or just a coffee house? Eddie Van Halen is still making money on his guitar patents, but when was the last time Van Halen had a hit record? Jerry Garcia of the Grateful Dead passed away in 1995, but the Jerry Garcia clothing brand is still going strong. Valuing a company requires evaluating actual value alongside perceived values and somewhere in between is the estimated market value. The challenge is that while the middle aged rock star (aka company) is looking in the mirror - they see themselves as a "rock legend". However, value is determined from the other side of the looking glass. Follow these steps, and you will have the right point of view for valuing a software start-up to a rockabilly come back artist.

Step 1a: Asset Value - Tangibles

Assets are what the company owns outright, like office equipment, vehicles, inventory etc. The list can get long and represents a tangible value. In other words, if the company closed its door today, this is the value of what could be sold. There is no guarantee of course what the actual sales would be and this value would be affected by debt and accounts payable. Nevertheless, tangible asset value is a form of perceived security blanket. If the company liquidates, this is the approximate value.

Step 1b: Asset Value - Intangibles

Google is no longer just the name of a company, it is a verb: how valuable is that? Lady Gaga reportedly held control of her song copyrights, as opposed to the record label. How much are those songs potentially worth? Could be millions, down the road it could be nothing. Complicated data models are used for estimates, but there are no real guarantees only educated guesses. The value of patents, copyrights, trademarks and reputation can be significant in driving up value. The more unique and exclusive - the more significant the value added.

Step 2: Income Value

What is the current income level? What are the key sources of income? Who are the clients? What contracts are in place? Are there current accounts receivable? Most importantly, how stable is the income level? Review the prior three years for income levels to show a trend. If the income chart is all up and away, do a little research to determine when it reasonably hit a plateau.
Next is the NET income. What are the ongoing expenses of operating the company? Gross Income - Less Expenses = results in NET INCOME. Review the expenses for their completeness, meaning not only is the electric bill and facilities rental, but salaries, insurance, contractor expenses, licensing and permits etc. Business owners might forget to determine what they take out as discretionary income.

Overall a properly completed balance sheet tells you the income, outflow and net present value. Reviewing the numbers AND the explanation behind them is paramount.

Step 3: Market Value

"Google" similar companies to see what they are selling for. Find three or four similar companies in size, offering and market share and find a maximum, minimum and average value among the list. Finding the market range, gives a viable benchmark for comparison.

Also, what is the perceived demand for what the company has to offer? Do they have a significant market share? Is there room for growth? How does the company maintain a competitive advantage or is it just a matter of time before competitors start taking their share?

Conclusion

Valuing a company on your own can be a daunting task - consider bringing in professionals to help crunch the numbers and get into the details. If a business is for sale, look for a third party accounting firm to have confirmed and compiled the financial statements. If it is a much smaller business, ask your accountant to take a look.

Most importantly, realize that looks can be deceiving and the company being evaluated has its own sense of value that may far exceed any calculated book value. Gather the facts on all that you can, and make educated guesses. Proper valuation sets up realistic opportunities return on investment. Keep in mind that an aged rock star that fills a coffee house may produce a higher return on investment than one with an empty stadium.