How to Forecast The Future Value of Your Company
A simple (but powerful) way to forecast multiple future scenarios and value your company
Valuing a Company is Tricky and Full of Error
Before we dive in, I want to make a few statements to help us contextualize the challenge we encounter when attempting to determine the value of a company (private or public; current or future):
No One REALLY Knows What Your Company is Intrinsically Worth (Including Your VCs)
While there are tools to help, determining "value" is ultimately very subjective (and sometimes emotionally charged). As contextual help, remember that Venture Capital Funds (i.e. the primary investors in your company if pre-IPO) generate returns for the fund with just a few huge winners; the majority of their investments fail.
Valuation Is a Function of Three Primary Things (per Financial Theory); Your Company Has No Control Over Two of the Three...
Market conditions (~50% of value). Your company has no control over this. As market conditions change (e.g. access to money, risk taking appetite, economic cycle, valuation multiples), so will the value of your company. Financial theory estimates this determines ~50% of value.
Industry conditions (~30% of value). Your company has largely no control over this. As industry conditions change (e.g. technological advancements, end-market-user-demand, competition, industry-specific economic cycle), so will the value of your company. Financial theory estimates this determines ~30% of value.
Company-specific dynamics (~20% of value). Your company does have control over this. Outliers can and do exist, but they're uncommon (hence "outliers"). It surprises many individuals at times, but financial theory estimates that company specific factors determine only ~20% of value. To reinforce this point, we recommend reviewing the VC-backed company exit rate data.
The Way Your Company Is Valued Can (And Likely Will) Change
Dozens of valuation models exists, each with pros/cons. And perhaps frustratingly, the preferred valuation methods/ratios used to determine valuation change over time too. For example, as interest rates have drastically risen in 2022/2023, investors are much more heavily prioritizing profit vs. growth.
You Should Still Forecast the Future Value of Your Company
With all of the data and details provided above, it may seem moot to try to estimate what you think your company might be worth in the future. We couldn't disagree more. Knowing that we (nor you) have a crystal ball, having an understanding of (and/or opinion on) what you believe the company might be worth is an important input for many of the decisions you need to make regarding your equity compensation.
How should we try to value a company then? By considering multiple possible scenarios and valuations, with the aim of being approximately correct versus precisely wrong.
Use a Probability Distribution Framework to Forecast
One of the challenges with determining a future valuation is a need to align on a single number (this creates a lot of false precision). An alternate (and much more favorable approach, we believe) is to fully embrace that your company's future valuation has a range of outcomes. Instead of trying to pick a specific one, we embrace the different outcomes, and focus on assigning a realistic probability to each.
Simple probability price forecast framework. Beautiful in its simplicity, a simple probability framework uses only a few key inputs:
Estimate the range of price outcomes. We recommend 5-7 price outcomes. You can pick the increase/decrease amounts if you prefer, but we believe the model below is a solid range for a technology company 2 years into the future.
Estimate the probability of each price outcomes. This is the key input. If you have strong opinions, definitely input them for the various scenarios. If you don't, we recommend reviewing the VC-backed company exit rate data and/or Tech company Post-IPO returns data to help inform your selections.
More advanced probability price forecast framework. For those that want to get deep in the weeds on this (we don't recommend it; we've found very little incremental value is added from this), a more advanced framework is possible by incorporating specific scenarios, their respective importance, and an estimated probability of their outcome:
Probability Distribution Framework + Stock Option Scenarios
One of the key end goals of forecasting future company stock prices and scenarios is to aid in the decisioning of what to do with your stock comp (e.g. exercise your options or not; and if so, how much). We find this analysis to be very useful with many clients, as it details exactly what their profit/loss and after-tax cash would be across a range of outcomes. But as with all forecasts that involve projecting taxes, it can be challenging to conduct and we strongly advise working with a tax professional for accuracy.
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