How is a company’s valuation determined before an IPO?

A company’s valuation before an IPO is primarily determined through various analytical methods that provide a comprehensive view of its financial standing and future potential. The correct approach involves utilizing techniques such as comparable company analysis, discounted cash flow (DCF) analysis, and precedent transactions.

Comparable company analysis involves evaluating similar companies in the same industry to gauge a fair valuation based on market multiples. DCF analysis calculates the present value of expected future cash flows, offering insights into how much investors might value the company today based on its future earnings potential. Precedent transactions look at the prices paid for similar companies in past deals to inform the valuation context.

Using these established methods allows underwriters and analysts to arrive at a more accurate and justified valuation that reflects market conditions and the company's financial performance and prospects. This contrasts with relying solely on stock market trends, past profits, or future predictions, which could provide an incomplete or skewed picture of the company's true value at the time of the IPO.