Contrast the key features of private and public companies that matter for valuation
The idea
Private companies differ from public ones in company-specific and share-specific ways. Company-specific differences include an earlier stage of life, smaller size, less depth of management, owners who are also managers, lower-quality or unaudited financial information, freedom from short-term market pressure, and often a focus on minimising tax rather than reporting profit. Share-specific differences include illiquidity, since there is no active market, restrictions on transfer, and concentrated ownership, which makes control an important issue. These features tend to raise required returns and call for valuation discounts. The trap is applying a public company's multiple or discount rate directly to a private business without adjusting for size, liquidity and the quality of the information.
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- Set out why private businesses are valued and what financial analysts should concentrate on
- Explain the difficulties of estimating cash flow for private firms and the adjustments needed to arrive at normalised earnings
- Explain what has to be adjusted when setting the discount rate for a private firm
- Contrast the models for estimating the return required on private company equity, such as the build-up approach, the CAPM and the expanded CAPM
- Explain and assess how control and marketability discounts and premiums change the value of a private company
- Explain the asset-based, market and income ways of valuing a private firm and what bears on choosing each one
- Value a private firm using methods based on income
- Value a private firm using methods based on the market and set out the pros and cons of each method