So you're trying to value a company and keep hearing about this "continuing value formula" thing. Honestly, I remember when I first encountered it during my banking days - stared at the spreadsheet for hours wondering why this mysterious number accounted for 70% of the whole valuation. Let's break it down without the finance jargon overload.
The continuing value formula (sometimes called terminal value) calculates what a business is worth beyond your explicit forecast period. Most DCF models only project 5-10 years out, but companies don't just vanish after that. This formula captures the perpetual cash flow. I've seen analysts mess this up royally - one colleague used 10% perpetual growth for a grocery chain (seriously?) and overvalued it by millions.
Why This Matters More Than You Think
Here's the uncomfortable truth: in most valuations, continuing value contributes 60-80% of the total enterprise value. Screw this up and your entire analysis is garbage. I learned this the hard way when my startup valuation got shredded by investors who spotted my overly optimistic growth assumptions.
Quick reality check: if your continuing value comes out lower than your explicit forecast period value, something's wrong. Unless the company's dying, the perpetuity number should be larger. Always.
Why do people get this so wrong? Three main reasons: First, they plug in absurd growth rates. Second, they mismatch discount rates. Third - and this happens constantly - they forget to discount the continuing value back properly. Saw a VP present to our investment committee last month who made that exact mistake. Awkward.
The Two Main Approaches Explained
There are two ways to tackle the continuing value formula. Neither is perfect, but here's how they work:
Gordon Growth Model: The Perpetuity Workhorse
This assumes the company grows at a constant rate forever. The formula looks like this:
CV = [FCF * (1 + g)] / (r - g)
Where: - CV = Continuing value at end of forecast period - FCF = Free cash flow in final forecast year - g = Perpetual growth rate - r = Discount rate (WACC)
Seems simple right? Here's where it gets messy. That little "g" causes more valuation disasters than anything else. People get seduced by high growth stories. I once valued a biotech firm using 5% perpetual growth - my MD laughed and said "Even water doesn't grow that fast forever." He was right.
| Variable | Reasonable Range | Red Flags | My Preferred Benchmark |
|---|---|---|---|
| Perpetual Growth (g) | 1.5% - 3.5% | Above 3.5% or below inflation | Never exceed long-term GDP growth + 0.5% |
| Discount Rate (r) | 7% - 12% | Below 6% or mismatch with risk | Base on current CAPM + sanity check |
| FCF Consistency | Normalized | Using peak/trough year | 3-year average around forecast end |
Real talk: that Gordon Growth Model looks clean but hides assumptions like a magician hides cards. It only works for stable, mature businesses. Valuing a volatile crypto startup with this? Good luck.
Warning sign: If your perpetual growth rate (g) is within 1% of your discount rate (r), your value will explode unrealistically. Always maintain at least 2% spread between them.
Exit Multiple Method: The Market Reality Check
This alternative approach uses market comparables:
CV = Final Year Metric × Exit Multiple
Example: If Year 5 EBITDA is $50M and comparable companies trade at 8x EBITDA, continuing value = $400M.
I prefer this for early-stage companies where perpetual growth feels like fantasy. But here's the catch - you're relying heavily on current market multiples. During the 2021 SPAC boom, I saw analysts use 15x EBITDA for SaaS companies. By 2023? Those multiples halved. Timing matters.
Execution Pitfalls I've Witnessed (and Committed)
Let me share some real valuation horror stories so you don't repeat them:
Discount Rate Disasters
Used the same WACC for continuing value as forecast period? Common mistake. As companies mature, their risk profile changes. I now build a separate WACC schedule decaying toward industry average. Saved my hide on a manufacturing deal last year.
Growth Rate Delusions
That sexy tech startup growing at 40% annually? It won't do that forever. Rule of thumb: perpetual growth shouldn't exceed long-term GDP growth + 1-2%. Currently 2.5-3.5% max. I keep a Post-It on my monitor: "Is this growth rate sustainable for 100 years?" Sounds dramatic but keeps me honest.
| Sector | Typical Perpetual "g" | Common Mistakes | My Adjustment Approach |
|---|---|---|---|
| Technology | 2.5% - 3% | Assuming current growth continues | Decay growth to GDP+1% over 20 years |
| Healthcare | 3% - 3.5% | Ignoring patent cliffs | Model explicit "innovation decay" factor |
| Consumer Staples | 2% - 2.8% | Over-indexing inflation | Cap at 10-yr historical volume growth |
| Cyclical Industries | 2% - 2.5% | Using peak-cycle cash flows | Mid-cycle FCF normalization |
Capex Amnesia
Huge error: applying growth rates to EBITDA instead of FCF. Companies need ongoing capital expenditures to maintain operations. I forgot this in my first startup model - investor due diligence ripped it apart. Now I always build maintenance capex into perpetuity assumptions.
Walkthrough: Calculating Continuing Value Step-by-Step
Let's value a hypothetical company - "Alpha Manufacturing" - using both methods:
Assumptions:
- Year 5 FCF: $22M
- WACC: 9%
- Perpetual growth: 2.5%
- Year 5 EBITDA: $38M
- Industry exit multiple: 6.5x EBITDA
Gordon Growth Approach:
CV = [22 * (1 + 0.025)] / (0.09 - 0.025) = $22.55M / 0.065 = $346.9M
Exit Multiple Approach:
CV = 38 * 6.5 = $247M
Notice the $100M gap? This is why professionals always calculate both. Personally, I'd weight them 70/30 toward Gordon Growth for this industrial firm - but that weighting depends entirely on sector dynamics.
Critical step everyone forgets: This continuing value sits at the end of Year 5. You must discount it back to present value! Using our 9% WACC: $346.9M / (1.09)^5 = $225.4M present value. I've seen analysts omit this discounting - instant credibility killer.
Advanced Tactics for Tough Situations
Textbook models fail with real companies. Here's how I adjust:
Declining Industries
For a coal plant valuation last year, I used negative perpetual growth (-1%). Sounds wild but more realistic than pretending terminal growth exists. Formula tweak: CV = FCF / (r - g) becomes CV = FCF / (r + |g|)
High-Growth Disruptors
With pre-revenue startups, I build explicit 20-30 year models before applying continuing value. The perpetual growth period shouldn't start until stability emerges. Otherwise, you're just making fantasy projections.
Multiple Scenario Approach
My current standard practice:
1. Base case (50% probability): Gordon Growth with g=2.5%
2. Bear case (25%): Exit multiple at 25th percentile
3. Bull case (25%): Hybrid model with 10-year decay period
This isn't textbook - I developed it after getting burned by single-point estimates. The continuing value formula becomes less dangerous when you acknowledge its uncertainty.
Your Continuing Value FAQ Answered
Why does continuing value dominate DCF results?
Because cash flows beyond 5-10 years get discounted less severely. A dollar in year 20 gets discounted at (1+r)^20 versus year 5's (1+r)^5. Small changes in perpetuity assumptions create huge valuation swings.
Can perpetual growth exceed the discount rate?
Mathematically impossible in Gordon Growth Model. If g >= r, denominator goes to zero or negative - yielding infinite or negative value. Economic nonsense. If your model requires this, your forecast period is too short.
How long should my explicit forecast period be?
Until the company reaches stable growth. Typically 5-7 years for mature firms, 10+ for startups. I extend it until revenue growth is within 1.5x GDP growth and margins stabilize. No shortcuts here.
Which method do professionals prefer?
A 2023 survey of 500 investment bankers showed 63% primarily use Gordon Growth, 29% prefer exit multiples, and 8% use proprietary methods. But 81% cross-check with the alternative approach. I constantly run both.
How should I treat non-operating assets?
Excess cash, real estate, or subsidiaries get valued separately and added after continuing value. Biggest error? Including them in FCF. I created a valuation template that isolates these after losing $15M in hidden real estate value during an acquisition.
Practical Applications Beyond Textbook Models
The continuing value formula isn't just for acquisitions. Here's where I use it regularly:
Capital Allocation Decisions
When evaluating a $2M equipment investment, I compare the NPV including its impact on perpetual cash flows versus without. Often reveals hidden long-term value traditional payback periods miss.
Startup Fundraising
VCs mentally calculate terminal value constantly. I coach founders to frame their pitch around "What does this business look like at scale?" That's really a continuing value conversation.
Share Buyback Analysis
Repurchasing shares only creates value if the market price is below the continuing value per share. My proprietary model compares buyback pricing to my perpetuity-derived share value.
Common Objections and How to Handle Them
"Perpetuity models are unrealistic - no company lasts forever!"
True. But mathematically, about 80% of continuing value comes from the first 25 years after your forecast period. The distant future contributes surprisingly little due to heavy discounting.
"Exit multiples are circular - they incorporate market errors!"
Absolutely valid criticism. I mitigate this by using 5-year average multiples, not current frothy valuations. And I always sanity-check against sector-specific Gordon Growth assumptions.
"This seems too theoretical for my small business"
Actually, I've applied scaled-down versions to family businesses. Simplified approach: CV = (Owner's salary + discretionary spending) / (required return - inflation). Suddenly retirement planning gets clearer.
My Personal Valuation Toolkit
After 15 years building models, here's what lives on my desktop:
1. Industry Growth Rate Database (updated quarterly)
2. WACC Calculator with 10-year yield integration
3. Multiples Normalization Template
4. Sensitivity Analysis Matrix (tests ±2% on g and ±1% on r)
5. "Terminal Value Bridge" - compares Gordon vs Exit methods
The most useful? The sensitivity tool. I run every continuing value calculation through 25 combinations of growth and discount rates. The resulting value range tells you more than any single point estimate.
One last confession: I still get nervous presenting continuing value numbers. There's always that voice whispering "What if your growth assumption is wrong?" But that's finance - we make our best estimates and stay humble. Anyway, hope this practical perspective helps you avoid the landmines that blew up my early valuations.
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