Valuation of Private vs. Public Companies. Private company valuations are discounted based on several risk factors associated with private sector investing, which results in a marked difference between the valuation of a privately held company, subsidiary or a division and a publicly traded corporation.

1. PRIVATE COMPANY VALUATION

2. COMPARE PUBLIC AND PRIVATE COMPANY
VALUATION
• COMPANY SPECIFIC FACTORS
1. Stage of lifecycle
2. Size
3. Quality and depth of management
4. Quality of financial information
• STOCK SPECIFIC FACTORS
1. Liquidity
2. Marketability
3. Concentration of control

3. • FAIR MARKET VALUE
• Tax purposes
• Hypothetical willing and able buyer and seller
• Arm’s length transaction in a free market
• Well informed buyer and seller
• FAIR VALUE
• Financial reporting purposes
• Arm’s length transaction
• Well informed buyer and seller
DEFINITIONS OF VALUE

4. • MARKET VALUE
• Frequently used for appraisals of real estate and other real assets
• Willing seller and buyer
• Arm’s length transaction
• Well informed buyer and seller
• INVESTMENT VALUE
• Value to a particular buyer. It may be different for different investors
• Perceived firm risk
• Appropriate discount rates
• Individual financing costs
• Perceived synergies with existing assets
Market Value & Investment Value

5. • SIZE PREMIUMS
• Size premiums are added to discount rates for small private companies.
• This is to account for the additional risk taken by investors for investing in small
firms.
• AVAILABILITY AND COST OF DEBT
• Private firms have less access to debt financing than public firms.
• Equity capital is usually more expensive than debt and higher operating risk of a
small company leads to a higher cost of debt, Hence WACC will typically be
higher for private firms.
FACTORS THAT REQUIRE ADJUSTMENT
WHILE ESTIMATING DISCOUNT RATES

6. • ACQUIRER vs. TARGET
• When acquiring a private firm, some acquirers incorrectly use their own
(lower) cost of capital
• They should be using the cost of capital of the target
• Because of using an incorrect discount rate, they arrive at a value of the target
that is too high
• PROJECTION RISK
• Because of lower availability of info for private firms, forecasting becomes difficult
• Management may under/over estimate future earnings
• Should be reflected in the form of a higher discount rate
Market Value & Investment Value

7. Scenario Comparable Data Subject Valuation Adjustment to
comparable data
1 Controlling Interest Controlling Interest None
2 Controlling Interest Noncontrolling
Interest
DLOC
3 Noncontrolling
Interest
Controlling Interest Control Premium
4 Noncontrolling
Interest
Noncontrolling
Interest
None
PREMIUMS/ DISCOUNTS FOR
CONTROLLING INTEREST

8. As developed by Michael Porter:
1. Threat of new entrants in the industry.
2. Threat of substitutes.
3. Bargaining power of buyers.
4. Bargaining power of suppliers.
5. Rivalry among existing competitors.
There are three generic strategies a company may employ in order to compete and
generate profits:
1. Cost leadership
2. Product differentiation
3. Focus
FIVE ELEMENTS OF INDUSTRY STRUCTURE

9. An Absolute valuation model is one that estimates an asset’s intrinsic value,
which is its value arising from its investment characteristics without regard to
the value of other firms.
• One approach is the discounted or present value of future cash flows. Dividend
discount models, Free cash flow, Residual income
• Another approach is the Asset Based model. This approach estimates a firm’s
value as the sum of the market value of assets it owns or controls.
A Relative valuation model determines the value of an asset in relation to the
values of other assets.
• The most common models use market price as a multiple of an individual
financial factor of the firm, such as earnings per share. The resulting ratio, Price-
to-earnings (P/E) ,is easily compared to that of other firms.
• If the P/E is higher than that of comparable firms, it is said to be relatively
overvalued. The converse is also true.
ABSOLUTE vs. RELATIVE VALUATION MODELS

10. • Conglomerate Discount is based on the idea that investors apply a markdown to
the value of a company that operates in multiple unrelated industries,
compared to the value of a company that has a single industry focus.
• Three explanations for conglomerate discount are:
1. Internal Capital inefficiency: The company’s allocation of capital to different
divisions may not have been based on sound decisions.
2. Endogenous factors: For example, the company may have pursued unrelated
business acquisitions to hide poor operating performance.
3. Research measurement errors: Some hypothesize that conglomerate discounts
do not exist, but rather are a result of incorrect measurement.
CONGLOMERATE DISCOUNTS

11. • Private Equity refers to a specific form of institutional investment in privately
owned companies with the objective to finance their transformation,
restructuring or expansion.
• The most prominent forms of private equity are venture capital (VC), i.e. equity
investments in the creation and growth of innovative ‘start‐up’ companies and
leveraged buyouts (LBO), i.e. acquisitions of majority‐stake equity positions in
mature businesses using additional debt funding.
WHAT IS PRIVATE EQUITY?

12. • Unlike public equity, private equity participations are not traded on the stock
exchange but owned by dedicated private equity funds.
• These hold their so‐called "portfolio companies” until the investment objectives
have been reached, typical over a period of 3‐8 years, and then sell them to
other financial or industrial buyers or list them on the stock exchange. Private
equity investments are thus longer‐ term in nature than the typical investment
on the stock market.
• Also, private equity funds are generally subject to fewer disclosure requirements
than publicly listed companies because they are closed vehicles in which the
general public cannot invest.
HOW IS PRIVATE EQUITY DIFFERENT
FROM PUBLIC EQUITY?

13. • Investments in PE funds are generally restricted to large and sophisticated
institutional investors, such as banks, insurances, pension funds, foundations,
sovereign wealth funds and high‐net‐worth individuals. These investors, often
called ‘limited partners’ are attracted to private equity funds as a possibility to
further diversify their investment portfolio and by the opportunity, to earn
attractive return generated by the best PE funds.
• The benefit of private equity also relies in the stable growth it provides to the
investors versus the boom and bust of financial market.
WHY DO PEOPLE INVEST IN PRIVATE
EQUITY FUNDS?

14. • Venture capital (VC) funds invest in small, young and innovative start‐up
companies with risky however exceptional growth potential, typically in areas
such as Information Technologies, Life Sciences.
• Investments are staged in several investment rounds to gradually finance the
growth of these companies. Typically, a start‐up has several VC funds as
shareholders, who provide not only cash, but also operational and strategic
support to support its development.
• Buyout funds invest in larger, mature businesses from all sectors of the economy.
These acquisitions are typically structured so that additional debt (leverage) is
used to finance the deal.
• Following the acquisition, the investing buyout fund(s) support the management
of the portfolio company to increase company value based on a variety of
initiatives, such as enhancing operational efficiency, improving strategic
distinctiveness and a focus on optimizing cash flows.
WHAT INVESTMENTS DO PRIVATE
EQUITY FUNDS MAKE?

15. • While both Private Equity and Hedge funds are classified as ‘alternative’
investments, i.e. different from traditional bonds and stocks, the two have little
in common.
• As stated above, Private Equity funds make long‐term pure equity investments
and seek to earn returns based on the growth or the transformation of the
underlying companies, hedge‐funds employ a range of investment strategies,
including short‐term arbitrage and short‐selling, in many different
underlying assets (rather than only equity).
• Both seek to provide attractive returns to investors and to offer diversification
benefits, but they do so based on completely different approaches.
WHAT DIFFERENTIATES PRIVATE
EQUITY AND HEDGE FUNDS?