We now turn to the question of determining the value of private company stock. We’ve seen how stock in private companies often can’t be sold, so its value is difficult to estimate.
The value of equity you cannot yet sell is a reflection of three major concerns:
How well the company is doing now—that is, how profitable it is, or how many customers it is attracting.
How well the company will perform in the future.
How likely it is the company will be valuable as part of another company—that is, whether it may be acquired.
The first concern is relatively clear, if you know the company’s financials. The second and third come down to predictions and are never certain. In fact, it’s important to understand just how uncertain all three of these estimations are, depending on the stage of the company.
In earlier stage private companies, there may be little or no profit, but the company may seem valuable because of high expectations that it can make future profit or be acquired. If a company like this takes money from investors, the investors determine the price they pay based on these educated guesses and market conditions.
In startups there tends to be a high degree of uncertainty about the future value of equity, while in later stage private companies financials are better understood (at least to investors and others with an inside view of the company), and these predictions are often more certain.