Reading 37

Private Company Valuation

One of the major applications of Equity Valuation is the Private companies’ valuation. Private companies’ valuation can be applied: • To value a Start up operations of Public companies. • To estimate a value of specific transactions i.e. 2.

acquisitions. • To estimate fair value of Goodwill for the purpose of impairment testing.

THE SCOPE OF PRIVATE COMPANY VALUATION

Private company can be a small firm with a single employee or unincorporated businesses, or public companies that have been taken private in management buyouts etc. 2.1 Private and Public Company Valuation: Similarities and Contrasts 2.1.1) Company-Specific Factors These are the factors related to the characteristics of the firm itself. These factors have both positive and negative impact on private company valuation. These include: • • • • • life cycle stage of the firm size of the firm markets in which the firm operates goals of the firm characteristics of management of the firm

being pressurized from external investors to enhance short-term profitability. *Agency costs: Issues arise from the conflicting interests of owners (principals) & managers (agents). Quality/Depth of Management: • Small private companies are less attractive to management due to their limited growth potential. • Due to small scale of operations, there is less management depth in these companies. • These factors further lead to higher risk and lower growth. Quality of Financial and Other Information: • There is limited availability of financial and other information for private companies. • The unavailability of financial information leads to uncertainty in valuation of such companies which further increases risk. • However, in cases where “fairness opinions” are required by firms i.e. in acquisitions, analysts are provided with unlimited access to financial information. Pressure from short-term investors: • Private companies do not face pressures regarding maintaining stock price performance in the short term. • Private companies can take longer term investment focus. Tax Concerns: • Private companies are more sensitive to reduction in reported taxable income and corporate tax payments than public companies. 2.1.2) Stock-Specific Factors These are the factors related to stock of a private company. These factors are usually negative for private company valuation. These include: • Liquidity of equity interests in business. • Concentration of control in private companies. • Potential agreements restricting liquidity.
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Stage in Life Cycle: • Private companies are typically less mature than public companies. • Private companies have less capital • Private companies have fewer assets and employees. • Private companies may also include large, stable, going concerns and failed companies in the process of liquidation. Size: • Private companies are usually smaller in size. • Private companies have higher risk due to their smaller size. • The higher risk inherent in private companies increases the risk premium and the required rate of return. • Smaller size also reduces growth opportunities as these companies have limited access to capital to fund investments. • However, smaller companies have advantage of low compliance costs. Overlap of Shareholders and Management: • Private companies have higher managerial ownership. This benefits the companies by eliminating agency costs*. Also, management is able to focus on long-term prospects of the company instead of

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2013

Reading 37

Private Company Valuation

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Liquidity of Equity interests in business: • Private company’s stock has low liquidity as compared to public company’s stock. • Private companies have small number of shareholders. Concentration of Control: • In private companies, only one or few investors have control. • This concentration of