How to value private companies

Wharton professor Andrew Metrick says private companies grow faster than the industry average, and continue to do so for five years after going public.

Here’s a New York Times summary.

Not sure whether this analysis will make money for VCs or public investors, because each individual company is different, and it’s intuitive that young companies grow faster than other companies — but the discussion is worth considering. His analysis shows Google as fairly priced.

To arrive at a realistic assumption for a specific start-up, Professor Metrick looks at the revenue growth rates of all other companies in its industry after they went public. He assumes that the start-up’s revenues will grow faster than those of 75 percent of the comparable initial public offerings — an assumption that gives the start-up a big benefit of the doubt.

Another crucial assumption involves how long a start-up can grow faster than its industry average. In his research, Professor Metrick found that the median start-up does so for five years after going public. Again, to give start-ups the benefit of the doubt, he assumes they can outpace their industry for seven years.

Armed with these and other assumptions, he can calculate the present value of a start-up’s future earnings.

Feedback welcome.

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