How Private Equity Firms Value a Company: A Practitioner's Guide

Private equity firms value a company by asking what they can pay and still earn their required return, given the debt they can raise and the exit they can credibly expect. They triangulate four methods (trading comparables, precedent transactions, a discounted cash flow model and an LBO model), but the LBO model usually sets the bid. Before any multiple is applied, due diligence rebuilds the earnings figure, because a buyer pays the multiple on every dollar of EBITDA it accepts.

The stakes show up quickly in the numbers. In a worked example in the research behind The Ownership Equation, a seller presented adjusted EBITDA of $56.6 million and guided buyers toward about 11 times. After diligence, the buyer's figure was $43.7 million. Equity value fell from $442.6 million to $276.7 million, a 37.5% drop, before anyone argued about the multiple. This guide walks through how a buyout investor gets from a seller's pitch to a bid.

How do private equity firms value companies?

The research summarizes the difference in one line. A public-market analyst asks "what is this business worth?" A buyout professional asks "what can I pay and still earn my required return?" Three facts shape the answer:

1. Equity is a residual. Equity value equals enterprise value minus net debt and debt-like items. Small errors in enterprise value become large errors in equity.
2. Returns are front-loaded in price. Every turn of EBITDA paid at entry must be earned back. In the research's model, paying 12 times instead of 11 times cuts the base-case IRR from about 17.8% to about 14.0%.
3. The exit is the largest single cash flow. In a five-year hold, almost all the value arrives in one number: exit EBITDA times exit multiple.

Step 1: Rebuild the earnings (quality of earnings)

Everything starts with EBITDA, and the seller's version is rarely the one to pay for. A quality-of-earnings (QoE) review tests each adjustment. The research's "Project Atlas," a hypothetical US industrial services company with $350 million of revenue, shows how.

Good diligence also finds negative adjustments the seller never shows. In Atlas, the buyer found $4.0 million: software development costs capitalized at a sharply higher rate, a founder-CEO paid far below what a replacement would cost, revenue booked before customer acceptance, and a one-off release of a bad-debt provision.

The bridge runs from $42.0 million of reported EBITDA, plus $5.7 million of accepted add-backs, minus $4.0 million of diligence deductions, to $43.7 million. The seller's $56.6 million was 23% higher. The principle behind the plant savings is worth remembering: improvements not yet achieved belong in the buyer's value creation plan, where the buyer earns them, not in the entry price, where the buyer pays for them upfront. Chapter 6 of the book covers what quality of earnings can and cannot establish, and the due diligence study has the full checklist.

A rule of thumb from the research: add-backs above 20% to 25% of reported EBITDA deserve deep scrutiny. Atlas's were 34.8%.

Step 2: Triangulate the valuation methods

Trading comparables

Comps value the target off the multiples at which similar public companies trade, usually EV/EBITDA, sometimes EV/revenue for fast growers or sector measures such as EV/ARR in software. Two cautions apply. Comps are a price for a small, liquid minority stake, with no control premium. And they reflect one day's sentiment: top-quartile software comps traded at about 15 to 25 times revenue in 2021, and many had halved by late 2022.

Precedent transactions

Precedents are multiples paid in earlier control acquisitions of similar businesses. They include a control premium (US take-privates have historically cleared at roughly 25% to 45% above the undisturbed share price, varying widely) and often strategic synergies. They go stale: a 2021 deal priced when base rates were low is a poor guide in a market priced off about 5% SOFR.

Discounted cash flow

A DCF discounts projected unlevered free cash flow and a terminal value. Private equity uses it mainly as a sanity check. Terminal value is typically 60% to 80% of the total, so the DCF often restates the exit-multiple assumption with extra steps. Its real use is forcing an explicit view on capital spending, working capital and the long-run growth a price implies.

The LBO model

The LBO model solves for the highest entry price that still delivers the sponsor's target return, given market leverage and a conservative exit. Large-cap buyouts historically targeted about 20% to 25% gross IRR. In the higher-rate, higher-multiple market of 2023–26, many large funds underwrite high-teens gross IRR and about 2.0 to 2.5 times the money.

Bankers call the LBO value a floor, because it shows what a financial buyer can pay without synergies. In frothy markets it often becomes the clearing price, because sponsors with record uninvested capital are the marginal buyer. Our worked LBO example builds one step by step.

The classic banker's "football field" chart plots all four ranges side by side. The expert reading focuses on why they disagree. If the DCF is far above comps, the projections are probably too optimistic. If precedents sit far above the LBO value, they were strategic deals or were priced when money was cheaper.

Step 3: Choose the multiple and defend it

An EV/EBITDA multiple compresses many assumptions into one number. Two companies with identical EBITDA can differ in growth, capital intensity, cash taxes, cyclicality, customer concentration and accounting quality. Chapter 7 of The Ownership Equation argues that the multiple should follow those differences rather than hide them.

Cash conversion matters most. The research defines it as (EBITDA minus capex, working capital change and cash taxes) divided by EBITDA. A software business converting 80% to 90% can carry about 7 times debt. An industrial converting 40% probably cannot safely carry 5 times. That is why sector specialists such as Thoma Bravo and Vista Equity Partners value software on recurring revenue and margins rather than on a generic multiple. Chapter 18 explains why different businesses need different measures.

For reference, the research's indicative calibration for US large-cap deals in 2024–26:

Step 4: Bridge from enterprise value to equity value

The headline price is enterprise value on a cash-free, debt-free basis. The seller receives equity value:

Enterprise value − financial debt − debt-like items + cash ± working-capital adjustment = equity purchase price

Debt-like items are where much of the negotiation happens. In Project Atlas, reported net debt was $180.0 million. Diligence added $24.0 million more: an unfunded pension ($6.0 million after tax), an earn-out owed on an earlier acquisition ($4.5 million), off-balance-sheet receivables factoring ($5.0 million), the cost to fulfill deferred revenue ($3.0 million), unpaid prior-year bonuses ($2.2 million), multi-state sales-tax exposure ($1.8 million) and unpaid capex ($1.5 million).

The working-capital peg is the other lever. It is the "normal" level of working capital the business needs to produce the EBITDA being paid for. If actual working capital at closing is below the peg, the price falls dollar for dollar. That stops a seller from stretching payables or accelerating collections just before the sale. A peg set $5 million too low on a $1 billion deal hands $5 million straight to the seller.

Putting the numbers together

Leverage turned a 23% gap in EBITDA into a 37.5% gap in equity value. An experienced buyer does not necessarily bid $480.7 million. It may pay part of the value of the unexecuted plant savings if it has done such a program before, for example $8 million to $15 million of a risk-adjusted $30.8 million. It deducts debt-like items in full. And it bridges any remaining gap with structure, such as an earn-out tied to the contracts that have not started, or a requirement that the seller roll part of its proceeds.

Watch the lender's EBITDA too

Credit agreements often allow broader add-backs than a buyer should pay for. In Atlas, adding stock-based compensation and the plant savings back produces "covenant EBITDA" of $48.9 million. A loan sized at "6.0 times" that figure is $293.4 million, which is really 6.71 times the diligence-adjusted EBITDA. Rating agencies and credit researchers have repeatedly flagged this add-back inflation in leveraged finance. The LBO modeling and valuation study covers both sides of the definition.

How valuation fits the four factors

The Ownership Equation treats a buyout as four multiplying factors: price, financing, operations and realization. Valuation is the price factor, and it is the only one fixed permanently on the day the deal is signed. Operations can be improved, financing can be renegotiated and the exit can be timed, but an overpayment stays in the return forever. KKR's RJR Nabisco buyout is the classic example of a sound business bought at a price that left investors roughly break-even. For how price connects to fees, carry and exits, see our guide to how private equity makes money.

The takeaway

Private equity valuation starts by rebuilding EBITDA, then triangulates comps, precedents, a DCF and, decisively, an LBO model that asks what price still earns the target return. The bridge from enterprise value to equity value, with its debt-like items and working-capital peg, decides what the seller actually receives. In the Atlas example, careful diligence cut the equity value by more than a third before the multiple was even debated. Chapter 7 of The Ownership Equation covers valuation and purchase-price mechanics in depth.