The Learning Hour*: Week 12 – Negotiation based valuation approach

There are various methodologies that are used in the real world to value any company.

Some of them are highly complex and technical like the Discounted Cash Flows approach, while some are simple but not very technical like the Multiples valuation approach.

There are also other methodologies like the Sum of the Parts valuation, Regression based approach, Options valuation which only increase in complexity in finding the valuation of a company.

In this article, however, we wanted to explore a very simple yet widely used valuation methodology.

The approach is basically a negotiation-based valuation methodology.

To explain this method, let us give you an illustration.

Let us say, there is an early stage company which has made a business plan.

As per that, they require a funding of U$ 1.5 mn to kick start their business operations.

They reach out to some potential investors to invest money in their company.

After a lot of discussions and deliberations, the investors agree to back this start-up company.

However, they need to be given equity ownership in the company in lieu of the money they would investors.

The founders and investors negotiate on 20% stake in the company. That is, the investors will get 20% stake in this company for U$ 1.5 mn funding,

Now, you may wonder, how did they arrive at 20% number?

Well, that is a million dollar question.