The valuation of new private companies is examined. Valuation tools (techniques) and decision-making processes are addressed in the examination.
The valuation process for new private companies occurs in two phases. The first phase is the pricing evaluation. The objective of this phase is to determine the initial offering price for shares in the new company. The second phase is the market evaluation. The results of this phase reflect the actual worth of the new company based on the market's response to the company's initial public offering (IPO). IPOs are equity stock issues when a corporation first initiates public trading of its shares.
Investors are interested in IPOs because they "offer the prospect of swift gains: a doubling of the share price on the first day of trading is not uncommon" ("American IPOs: What Crash?" 1997, p. 83). Over time, however, IPOs generally tend to under perform in relation to the market as a whole.
In 1997 as an example, 469 IPOs had been floated in stock markets in the United States through mid-November ("American IPOs: What Crash?" 1997). These IPOs generated $24.2 billion for the issuing corporations. In the wake of the seven-percent drop in the Dow-Jones Industrials Index that occurred in October 1997, small investors, seeking quick returns as the bull market appeared to be imperiled, began turning to IPOs in greater numbers ("American IPOs: What Crash?" 1997).
Such a strategy is not risk-free. While, as stated above, it is not uncommon for the market value of an IPO to double during the first day of trading, that pattern is not a given. The market price for average IPOs increase in the range of 15-to-20 percent over the initial two weeks of trading activity and many lose value over that period (Raymond James Financial, 2000).
Valuation Tools and Decision-Making Processes
Several factors are considered in both the setting of an IPO price and in the evaluation of an IPO pr...