Which valuation method is commonly used for private companies?

Discounted cash flow (DCF) analysis is a widely accepted valuation method for private companies because it focuses on forecasting the future cash flows that a business is expected to generate and discounting those cash flows back to their present value. This approach is particularly beneficial for private firms, as it allows valuators to assess the intrinsic value of a company based on its potential financial performance, independent of market prices that may not be readily available or reliable, given the lack of a public market for these firms.

DCF is driven by the company's projected revenue, expenses, and investments, thereby providing a more comprehensive understanding of its operational efficiency and growth potential. Unlike market capitalization, which relies on stock prices that are unavailable for private companies, or the P/E ratio, which may not fully reflect the unique characteristics of private entities, DCF allows for a nuanced valuation based on detailed financial modeling tailored to the specific situation of the business. Asset-based valuation, while useful in certain contexts, often does not capture the value created by the company's future earnings potential, making DCF a more effective method for assessing private companies.