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Equity Valuation > Private Company Valuation > Flashcards

Private Company Valuation Flashcards

1
Q

What are 6 company specific factors that are most relevant for valuation purposes for private vs public companies?

A
  • stage life cycle (private companies typically early stage of development)
  • size private company’s tend to be smaller)
  • concentrated ownership (private companies are majority owned by founders)
  • limited disclosures (public companies required to disclose financial information, private aren’t required too)
  • pressure from short-term investors (private companies focus on long-term growth while public short-term)
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2
Q

What are 3 stock specific factors that are most relevant for valuation purposes for private vs public companies?

A
  • illiquid shares (private company shares is illiquid)
  • concentrated control (private companies controlled by one or few investors)
  • potential sales restrictions (private companies can restrict ability for owners to sell their shares)
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3
Q

What are 3 categories in which private companies valuation can be categorized based on what they are related to?

A
  • transaction related
  • compliance
  • litigation
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4
Q

What are 7 transaction related purpose of private company valuation?

A
  • venture capital financing (early stage):
  • private equity financing (growth or buyout stage)
  • debt financing
  • initial public offering
  • acquisitions and divestitures
  • bankruptcy
  • share based payment (compensation)
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5
Q

What are 2 compliance related purpose of private company valuation?

A
  • financial reporting
  • tax reporting
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6
Q

What are 2 litigation related purpose of private company valuation?

A
  • corporate disputes
  • shareholder disputes
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7
Q

What is formula for enterprise value and formula for FCFF using in enterprise value formula?

A

enterprise value = (FCFF / (1 +WACC)^i)) + (terminal value / (1 + WACC)^n))

FCFF = EBITDA * (1-t) + depreciation - change in long term assets - change in working capital

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8
Q

When calculating enterprise value for a private company what are 3 adjustments usually needed?

A
  • earnings normalization: formula for FCFF is different
  • discount rate/ rate of return adjustments: WACC needs adjustments for private companies since WACC is usually used for public companies using CAPM
  • valuation discount or premium: due to the illiquidity a premium is usually added
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9
Q

What is the difference between buyout funds and growth funds?

A
  • buyout funds: raise large amounts of debt to finance highly leveraged acquisitions of public companies, buying all of their shares to take them private
  • growth funds: typically take minority stakes in rapidly growing companies with a view to exiting these positions at a higher valuation
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10
Q

What is the difference between compiled financial statements and reviewed financial statements?

A

-compiled financial statements: based statements and doesn’t include any insurance from auditors
- review financial statements: statements accompanied by auditors letter

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11
Q

When valuing a private company why do analyst need to make adjustments to normalize earnings and cash flows?

A
  • compiled and reviewed financial statements do not necessarily provide an accurate picture of what a private company’s operations would be like after an acquisition
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12
Q

What are 3 cash flow estimation issues for private companies?

A
  • Estimates of FCFE will depend on whether an investor is seeking to become a majority owner or taking a minority stake
  • Private companies are generally subject to higher levels of uncertainty
  • Managers of private company managers generally know much more about the business than outside analysts, managers may be inclined to bias their results
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13
Q

What is formula for WACC?

A

WACC = wdrd * (1-t) + were

wd = weight of debt
rd = rate of debt
t = tax rate
we = weight of equity
re = rate of equity

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14
Q

What is formula for cost of equity using CAPM?

A

re = rf + B(Rm - Rf)

re = cost or rate of equity
rf = risk free rate
b = beta
rm = return on market

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15
Q

What is formula for cost of equity using extended CAPM?

A

re = rf + B(Rm - Rf) + small cap stock premium + company specific stock premium

re = cost or rate of equity
rf = risk free rate
b = beta
rm = return on market

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16
Q

What is formula for cost of equity using build up method?

A

re = rf + (Rm - Rf) + small cap stock premium + company specific stock premium + industry premium/discount

re = cost or rate of equity
rf = risk free rate
rm = return on market

17
Q

What are the 2 types of investors for private company valuation?

A
  • strategic buyers: a company or investor that seeks to acquire companies or assets, whose acquisition will add synergistic value to their existing portfolio
  • financial buyers: attracted by a private company’s fundamentals and are willing to pay a control premium in order to establish a majority ownership position
18
Q

What is discount for lack of control vs discount for lack of marketability?

A
  • investors who are only seeking a minority ownership position will offer a share price that reflects a discount for lack of control (DLOC)
  • if the sale agreement includes conditions that restrict the buyer’s ability to sell their shares in the future, the price will reflect a discount for lack of marketability (DLOM)
19
Q

What is formula for lack of control discount and for DLOC and DLOM combined?

A

DLOC = 1 - (1/1+ control premium)

DLOC = discount for lack of control

total discount = 1 - ((1-control discount)*(1-marketablity discount))

20
Q

What are the 3 major approaches to private company valuation?

A
  • income approach (discount present value of expected cash flows)
  • market approach (relative value approach by comparing multiples to share price)
  • asset based approach (value of assets - value of liabilities)
21
Q

What is formula for free cash flow valuation method under income based approach?

A

Intrinsic value = (FCFF / (1+WACC)^i) + (terminal value / (1+WACC)^n)

22
Q

What is the formula for enterprise value for capitalized cash flow method under the income based approach?

A

enterprise value = FCFFk+1/ WACC - g = (EBITk+1 * (1 - t) * (1 - RIR)) / (WACC - g)

RIR = reinvestment rate

23
Q

What is formula for reinvestment rate (RIR)?

A

RIR = g / WACC

g = constant growth rate
WACC = weighted average cost of capital

24
Q

What is the formula for equity value for capitalized cash flow method under the income based approach, and what is the capitalization rate?

A

equity value = FCFEk+1 /re -g

Re = required return on equity
g = constant growth rate
FCFE = free cash flow to equity

capitalization rate = re -g

25
Q

What is the 4 steps to using the excess earnings method (EEM) (aka residual income model) to calculate enterprise value under the income based approach?

A
  1. Calculate required returns on working capital and fixed assets
  2. Calculate residual income
  3. Capitalize residual income
  4. Calculate enterprise value
26
Q

What is the formula for required returns on working capital and fixed assets of step 1 Calculate required returns on working capital and fixed assets of the excess earnings method (residual income model)?

A

required return on working capital = working capital * rwc

required return on fixed assets = fixed assets * rfa

rwc = rate of return on company’s working capital
rfa = rate of return on company’s fixed assets

27
Q

What is the formula for calculate residual income for step 2 Calculate residual income of the excess earnings method (residual income model)?

A

normalized income - required return on working capital - required return on fixed assets = residual income

28
Q

What is the formula for value of intangibles for step 3 capitalize residual income for the excess earnings method (residual income model)?

A

value of intangibles (aka residual value) = ((residual income) * (1+g)) / (rRI - g)

g = constant growth rate
rRI = required rate of return on residual income

29
Q

What is the formula for firms enterprise value for step 4 calculate firms enterprise value for the excess earnings method (residual income model)?

A

value of intangibles (aka residual value) + fair value of working capital + fair value of fixed assets = total firm enterprise value

30
Q

What are the three major market-based valuation techniques.

A
  • guideline public company method: uses observed multiples from the trading activity of public companies, adjusted for the private company’s risk and growth prospects.
  • guideline transactions method: uses pricing multiples from past acquisitions of entire public or private companies.
  • prior transaction method: uses actual past transactions for the subject private company.
31
Q

What is formula for unlevered beta for public company to compare for private companies?

A

B unlevered = B levered / [1 + (1-t) * (debt/equity)]

t = tax rate

32
Q

What is formula for levered beta that’s used in unlevered beta calculation for public company to compare for private companies?

A

B levered = B unlevered * [1 + (1-t) * (debt /equity*)]

t = private company’s tax rate
debt* = private company’s debt
equity* = private company’s equity

33
Q

What is a control premium, and what are 3 factors analysts should consider when determining if valuation of public company should be adjusted to reflect control premium?

A
  • control premium: when investors owns a controlling majority of company
  • type of buyer
  • industry dynamics
  • forms of consideration
34
Q

What are 5 factors analyst must consider when developing transaction based multiples?

A
  • synergies
  • contingent considerations
  • non cash considerations
  • availability/ relevance of transaction data
  • changes between valuation date and transaction date (takes time and data can change between time)

Equity Valuation (6 decks)

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