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CFA Level II > 24 (EV) - Private Company Valuation > Flashcards

24 (EV) - Private Company Valuation Flashcards

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1
Q

What are the company-specific factors to consider when valuing a private company?

Do these factors tend to positive or negative with regard to valuation?

A
  1. Less mature
  2. Less capital and fewer assets
  3. Fewer employees and less depth of management
  4. Riskier investments
  5. Higher managerial ownership
  6. Longer-term focus
  7. Fewer disclosures about the company
  8. Greater tax concerns

The above factors can have positive or negative effects on private company valuation.

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2
Q

What are the company-specific factors to consider when valuing a private company?

Do these factors tend to positive or negative with regard to valuation?

A
  1. Less liquidity in the equity interests
  2. Restrictions on liquidity or marketability
  3. Concentration of control to the potential detriment of noncontrolling shareholders.

The above factors tend to have a negative effect on private company valuation.

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3
Q

Compared to public firms, is there more/less heterogeneity for private firm risk, discount rates, and valuation methods?

A

More heterogeneity compared to publicly-traded companies.

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4
Q

What are the three major uses of private company valuation?

A
  1. Transactions
  2. Compliance
  3. Litigation
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5
Q

What are common transaction-related valuations in private company valuation?

A
  1. VC financing rounds
  2. IPO
  3. Sale of firm in acquisition
  4. Bankruptcy proceedings
  5. Performance-based managerial compensation
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6
Q

What are common compliance-related valuations in private company valuation?

A
  1. Financial reporting
  2. Tax purposes
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7
Q

What are common litigation-related valuations in private company valuation?

A
  1. Shareholder lawsuits
  2. Damage claims
  3. Lost profits
  4. Divorces
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8
Q

What are the three major approaches to private company valuation?

What are the major characteristics an analyst should consider when deciding on a private company valuation approach?

A
  1. Income approach
  2. Market approach
  3. Asset-based approach

Things to consider:
1. The firm’s operations
2. Lifecycle stage
3. Size
4. Risk
5. Growth

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9
Q

Income Approach to Private Company Valuation

A

Valuing a firm as the present value of its expected future income.

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10
Q

Market Approach to Private Company Valuation

A

Valuing a firm using the price multiples based on recent sales of comparable assets.

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11
Q

Asset-based Approach to Private Company Valuation

A

Valuing a firm by subtracting liabilities from assets.

Firm Value = Assets - Liabilities

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12
Q

What is the appropriate earnings definition to use when valuing a firm?

A

Normalized Earnings

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13
Q

Normalized Earnings

A

The firm’s earnings if the firm were to be acquired. Earnings adjusted for firm-specific characteristics.

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14
Q

Normalized earnings are calculated by adjusting for?

A
  1. Nonrecurring and unusual items
  2. Discretionary expenses
  3. Nonmarket levels of compensation
  4. Personal expenses charged to the firm
  5. Real estate expenses based on historical cost
  6. Nonmarket lease rates
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15
Q

When calculating normalized earnings, when do they also include acquisition synergies?

When does it not include acquisition synergies?

A

Included when a strategic is acquiring the company.

Not included when a financial (non-strategic) is acquiring the company.

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16
Q

When estimating free cash flow to value a firm or equity, what issues should be considered?

A
  1. Controlling or non-controlling equity interests
  2. Different scenarios of future cash flows
  3. Such scenarios should also consider the life-cycle stage of the firm
  4. Management biases
  5. FCFF when there is capital structure changes
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17
Q

When would one calculate free-cash-flow to the firm (FCFF) when valuing a private company?

A

When the transaction will result in capital structure (debt & equity levels) changes.

18
Q

What are the major factors that need to be considered when adjusting the discount rate for private companies?

A
  1. Size premiums - small-cap publicly traded firms may include a distress premium when a private firm would not so would not be good comps.
  2. Availability and cost of debt - Debt may be less available and at higher rates for private firms.
  3. Acquirer vs. target - WACC should be used for the target firm.
  4. Projection risk - Harder to project for private firms given less information available.
  5. Lifecycle stage - Harder to estimate an accurate discount rate for early-stage firms.
19
Q

What three models are used to estimate the required rate of return for private company equity?

A
  1. CAPM
  2. Expanded CAPM - Includes size and fire-specific risk premiums.
  3. Build-Up Method
20
Q

Why may the CAPM model not be appropriate for estimating the required rate of return for a private company?

A

CAPM uses beta which is usually estimated from public firm returns.

21
Q

When would one use the build-up method?

A

When beta for comparable public firms is not available.

22
Q

When would one use the asset-based approach when valuing a private company?

A

This approach is used for troubled firms, financial firms, investment companies, firms with few intangible assets or very small companies, and natural resource firms.

23
Q

What discounts/premiums should be applied when valuing a private company?

A

Discounts or premiums for control and marketability.

24
Q

What is more valuable? Controlling equity position or non-controlling equity position?

What is more valuable? A marketable (liquid) shares or less marketable shares position?

A

Controlling equity position as it will allow the majority owner to determine company strategy and dividend policy.

Marketable shares are more valuable.

25
Q

Discount for Lack of Control (DLOC)

A

Discount applied in private company valuation when the valuation is being done by a minority interest in the target company.

26
Q

Discount for Lack of Marketability (DLOM)

A

Discount applied in private company valuation when shares of the target company are less marketable than other highly marketable shares or securities.

27
Q

What are the three market-based approaches to valuing a private company?

A
  1. Guideline Public Company Method (GPCM)
  2. Guideline Transactions Method (GTM)
  3. Prior Transactions Method (PTM)
28
Q

Guideline Public Company Method (GPCM)

A

A valuation method that uses price multiples from publicly traded companies with adjustments for risk differences.

29
Q

Guideline Transactions Method (GTM)

What issues should one take into account when using this method?

A

A valuation method that uses price multiples from the sale of whole public and private companies with adjustments for risk differences.

  1. Transaction type
  2. Contingent consideration
  3. Types of consideration
  4. Availability of data
  5. Date of data
30
Q

When using the GPCM method, what issues should be considered when estimating a control premium?

A
  1. Transaction type (Control v. non-control)
  2. Industry conditions
  3. Type of consideration
  4. Reasonableness
31
Q

Prior Transactions Method (PTM)

A

A valuation method that uses historical stock sales of the subject company and is best when using recent, arm’s-length data of the same motivation (strategic or financial).

32
Q

What are the three income-based approaches to valuing a private company?

A
  1. Free cash flow method
  2. Capitalized cash flow method
  3. Excess earnings method
33
Q

Free cash flow method

A

Two-stage model. An approach that discounts a series of discrete cash flows plus a terminal value.
It essentially uses the dividend discount model and projects a terminal value.

34
Q

Capitalized cash flow method

A

Single-stage model. An approach that discounts a single cash flow (e.g. FCFF or FCFE) b ythe capitalization rate (i.e. WACC).

35
Q

Excess earnings method

A

An approach that values tangible and intangible assets separately.

36
Q

When is the excess earnings method most helpful?

A

Small firms that have a lot of intangible assets to value.

37
Q

What drives a higher DLOM? What drives a lower DLOM?

A

Higher DLOM:
1. Further restrictions on selling the shares/stock
2. greater risk and value uncertainty

Lower DLOM:
1. Impending IPO or firm sale
2. Payment of dividends
3. Earlier and higher payments
4. A greater pool of buyers

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CFA Level II (12 decks)

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