How is the value of a company judged?

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1. How is the value of a company judged?

In terms of value, it might be whatever someone will give you, if you are selling YOUR BUSIENSS, for example.
The textbook approach to valuation that many business owners are taught goes as follows:
• Take the fifth year financial projections from your business plan (you do have a plan, don't you?).
• Determine a price/earnings ratio (P/E) for public companies in your industry, and adjust it for what you think it will be in five years.
• Apply that P/E to your fifth year earnings. That is the potential value of your company in five years, assuming it could go public.
• Discount that number by the Internal Rate of Return (IRR) that potential investors in your company will be seeking (40% would be a good guess). That gives you the theoretical value of your company today.
• Divide the amount of investment by that valuation, and that will be the percent of your company that you will be willing to sell to the investor.
Seems reasonable. Probably is in many respects. But it has little-to-no-bearing on the valuation you will discuss with an investor, for example. http://texasvc.weblogswork.com/2006/08/04/what-is-your-company-worth/

Example: (excerpt)

First, let's take the position of the seller. It's fairly normal to expect that the seller of a business is responsible for getting the process started by listing an asking price for the business. The seller has all the insider information about the company's cash flows, assets, employees, contracts, legal affairs, financial structure, partnerships and other alliances. The seller has the most complete perspective on the true numbers that comprise the firm's valuation. In starting the process, the seller essentially says, "Attention interested parties: We believe the firm is worth this much, and we have provided solid, tangible evidence and rationale to support that figure." The biggest concern of the seller's valuation deals with disclosure.
There are four ways to view this. The value seems well documented, offers good rationale and is presented with a solid disclosure to support that figure. The second is the other extreme - that the value comes across as poorly documented, with highly questionable and suspect underlying rationale, and is presented with minimal (if any) disclosure to the prospective buyers. The other views are less cut and dry for the buyer to approach. The value could be accompanied by several documents and a well-honed story to support the premise for the asking price, but when it comes to very specific, footnoted disclosure, the seller does not give away the details necessary for the buyer to weigh the pricing. The fourth way involves what appears to be a lot of disclosure, but the methodology and rationale on using all this disclosure are inappropriately applied and the valuation doesn't quite make sense.
The second position, that of the buyer, is similar to the seller's in that a value must be determined and then held to, even in the face of the other party disagreeing with that number. But while the seller has the insider information on the true numbers and detailed descriptions of the company's operations, the buyer is left to work with limited or speculative information only and must rely almost exclusively on his or her own due diligence in making the offer price to the seller. Many deals are assumed to begin with the buyer at a distinct disadvantage because of the lack of symmetry in the amount and credibility of the information available in assessing the value of the company.
Finally, they both want to know how the negotiation process should proceed given all the back-and-forth of asking prices and counter offers. The key here is that the seller usually tries to drive the negotiation process based upon the insider perspective brought to the table. For example, the seller can always say, "I know this piece of information is such and such, because I've been running the firm for the past several years, so regardless of what the industry averages are, this is the correct measure for this particular area." What usually ...