The question I am asked most frequently by European entrepreneurs I know is: “How much is my company worth ?” I’ll pull a Henry Kissinger and answer a slightly different and more precise question, which is that of how VC’s in Europe calculate valuations of tech companies.

Even if it’s more precise, the answer still varies widely, so let’s narrow the scope even further. Let’s restrict ourselves to the IT/TMT segment (i.e. excluding life science and energy ventures). Also, the vast of majority of European VC’s only invest in businesses with some minimum initial revenue traction.

That leaves three primary valuation methodologies:

The Discounted Cash Flow method (DCF)

The DCF method involves estimating the company’s future cash flows and discounting them at the cost of capital to calculate the net present value. With the right inputs, this method is scientifically the most accurate way to determine the true, or intrinsic, value of a company. The challenge in applying this method to valuing early-stage companies is that it requires far too much precision in a context of far too much uncertainty, so it is generally not appropriate in the VC setting.

The VC Method — to be discussed later…

The “VC method” comes in many different flavors which I’ll try to explain in a future post.

The Comparables Method

Let’s focus on the Comparables method, which is very common among VC’s that are investing in revenue-stage companies. The Comparables method involves picking a basket of publicly-listed companies (i.e. the “Comps”) which resemble the company you want to value, and assessing their respective valuations as a multiple of some quantifiable indicator for each Comp.

In homage to our recent series on IPO’s, I’ll apply this model to the example of Facebook.

First, if you haven’t seen it yet, I recommend reading Henry Blodget’s excellent article on his calculation of Facebook’s value. While he didn’t reveal his exact calculation, Blodget applied a form of the Comparables Method in his analysis. His analysis resulted in a fair valuation of Facebook to be the range of $16~24 per share.

The image below links to my valuation model for Facebook based on the Comparables method which you’re welcome to borrow. I left it in PDF format for legibility, but if you’d like the Excel version feel free to ask.

In contrast with Blodget’s analysis, I extended my basket of Comps to include social networking businesses LinkedIn and Renren (in addition to Google and Apple, which Blodget used). I also added a weighting factor to the different Comps. For example, I assigned Apple a weighting of 1/3, while for LinkedIn, which I consider to more closely resemble Facebook in business model, I assigned a 3/3 weighting. Finally, I applied my analysis to multiples of Revenue and Ebitda (whereas Blodget focused on a multiple of earnings), and centered on the years of 2011, 2012, and 2013. The fundamental principles of my method are the same, but I was curious to see how a slightly different approach would stack up against Blodget’s analysis.

This approach using the Comparables method suggests a valuation for Facebook of approximately $20 per share.

The fact that my model’s estimation happens to fall almost smack on the midpoint of Blodget’s analysis is somewhat coincidental, but it also demonstrates why the Comparables method is so relevant for VC valuations.  It offers a fairly consistent range of guidance even under slight variations in application or in the choice of Comps used.  The fact is that nobody can calculate with certainty the fair valuation of a private company; these models only provide the guidance for an informed negotiation between willing parties.