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Sometimes a short answer is the simplicity on the other side of deep understanding. Do you value an ounce of gold based on the hours that went into mining and

Sometimes a short answer is the simplicity on the other side of deep understanding. Do you value an ounce of gold based on the hours that went into mining and refining it, or a Picasso based on the quantity of paint that went into it? It's worth the value the buyer can get out of it, not what you put into it. Typically that's the expected values of future cash flows, discounted to the present using an appropriate risk-adjusted discount rate. You can estimate how much cash it might generate under various scenarios, and estimate the probability of those scenarios transpiring, to come up with a value. If you can persuade someone there is future cash flow, you can sell it. Otherwise, you can get a dime for it if you throw in a couple of nickels. (disregarding strategic, humanitarian reasons to buy it, or the possibility someone is planning to spend X hours to build the exact same thing.)

joelhaus 16y ago
Taking exception with some of the above statements on valuation. There are actually three relevant methods for deriving a value, with the circumstances & audience dictating which approach (be it single or blended) to use: 1) Income Method As stated, discounted cash flows. 2) Replacement Cost What would it cost me today to recreate this asset from scratch? 3) Comparable Sales What price has recently been paid for similar assets? My assumption was that the OP brought this up because he needed to justify a valuation to the co-founders, not because he is trying to dictate a replacement cost to potential buyers. NB. There are many nuances to each of these approaches and most situations can be taken into account with the appropriate tweaks; if anyone is curious, there are firms which specialize in this or you can start here: http://en.wikipedia.org/wiki/Business_valuation http://en.wikipedia.org/wiki/Business_valuation
- RockyMcNuts 16y ago
  First, note my parenthetical comment. Second, your answer is to a different question - what is a reasonable theoretical valuation for a minority shareholder based on various potential outcomes? Not: at what price could I sell 100% of the asset in the market right now? An actual cash purchaser is always giving up a current cash flow because they expect a larger future cash flow. In your example, 2 and 3 can also be viewed based on cash flows. If you plan to build the same thing, buying it instead eliminates the negative cash flow of building it. Comparable transactions are based on how others valued comparable cash flows. Economically, it's always about the cash flow. Of course, economics isn't everything, there are trophy properties, social motives etc.

joelhaus 16y ago

Taking exception with some of the above statements on valuation. There are actually three relevant methods for deriving a value, with the circumstances & audience dictating which approach (be it single or blended) to use: 1) Income Method As stated, discounted cash flows. 2) Replacement Cost What would it cost me today to recreate this asset from scratch? 3) Comparable Sales What price has recently been paid for similar assets? My assumption was that the OP brought this up because he needed to justify a valuation to the co-founders, not because he is trying to dictate a replacement cost to potential buyers. NB. There are many nuances to each of these approaches and most situations can be taken into account with the appropriate tweaks; if anyone is curious, there are firms which specialize in this or you can start here: http://en.wikipedia.org/wiki/Business_valuation http://en.wikipedia.org/wiki/Business_valuation

RockyMcNuts 16y ago
First, note my parenthetical comment. Second, your answer is to a different question - what is a reasonable theoretical valuation for a minority shareholder based on various potential outcomes? Not: at what price could I sell 100% of the asset in the market right now? An actual cash purchaser is always giving up a current cash flow because they expect a larger future cash flow. In your example, 2 and 3 can also be viewed based on cash flows. If you plan to build the same thing, buying it instead eliminates the negative cash flow of building it. Comparable transactions are based on how others valued comparable cash flows. Economically, it's always about the cash flow. Of course, economics isn't everything, there are trophy properties, social motives etc.