Private Company Valuation

Until now we have focused on the valuation of publicly held companies with periodic audited financial statements and an observable market-based share price. Private companies are those whose shares are not listed on public markets ranging from sole proprietorships to multigenerational family businesses to formerly public companies that have been taken private in management buyouts or other transactions. Many large, successful companies exist that have remained private since inception, such as the Tata Group in India, IKEA and ALDI in Europe, and Cargill and Bechtel in the United States.

The process of valuing private companies based on discounted cash flows or relative value based on multiples is the same as for public companies. However, the lack of market pricing, audited financial statements in some cases, concentrated control, and other issues unique to privately held firms require adjustments to the valuation process. In what follows, we identify and address these differences, introduce principles of private company valuation, and demonstrate their application using several examples. These principles apply to firms of different sizes, life-cycle stages, and ownership structures, as well as other private markets such as real estate and infrastructure.

• In contrast to public companies, private companies which choose not to or cannot access public equity markets range widely in size, stage of development, and quality of financial disclosure and often involve illiquid, concentrated ownership directly held by the company’s management or private equity investors.
• Private company valuations are conducted to facilitate transactions, ensure compliance with financial or tax reporting, or resolve legal disputes. Key areas of focus include cash flow and earnings issues, discount rate or required rate of return adjustments, and valuation discounts or premiums.
• Cash flow and earnings adjustments for private companies aim to identify and address financial statement inconsistencies to ensure their relevance as a baseline for forecasting future earnings.
• Discount rates representing a private company’s cost of capital or cost of equity are usually adjusted for company-specific factors including size and lack of public market access. The limited applicability of CAPM to private company rates of return results in the use of an expanded CAPM or a build-up approach which adds risk premia to the risk-free rate.
• Adjustments to private company value involve the application of a control premium, or a lack of control and marketability discount based upon the circumstances of specific private companies and their shareholders.
• Valuation approaches for private companies are conceptually similar to those used for public companies and include an income approach based upon discounted cash flows, a market approach based upon price multiples of firms with similar features, and an asset-based approach which seeks to estimate the value of underlying assets less liabilities.
• The process of valuing a mature private firm using an income- or market-based approach often involves using comparable public companies to estimate a company’s cost of capital or price multiples.