Reading 39 - Private Company Valuation Flashcards
What are some of the company specific characterstics that distinguish private and public companies?
- Stage of lifecycle
- Size
- Quality and depth of management
- management/shareholder overlap
- short term investors
- quality of financial and other information
- taxes
What are some of the stock specific differences between private and public firms?
- liquidity
- restrictions on marketability
- concentration of control
What are the 3 reasons for valuing private companies?
- Transaction Related Valuations - are necessary when selling or financing a firm
- Compliance Related Valuations - are performed for legal or regulary reaons and primarily focus on financial reporting and taxes
- Litigation Related Valuations - may be required for shareholders suits, damage claims, lost profits claims, or divorce settlements
What are the different scenarios when Transaction Related Valuations would be used?
- Venture capital financing
- Initial Public Offering
- Sale in an acquisition
- Bankruptcy proceeding
- Performance Based Managerial Compensation
What are the different scenarios when Compliance Related Valuations would be used?
- Financial Reporting
- Tax Purposes
What are the 3 major approaches to private company valuation?
- Income Approach
- Market Approach
- Asset-based Approach
Explain the Income Approach in private company valuation….
Values a firm as the present value of expected future income.
Explain the Market Approach in private company valuation….
values a firm using the price multiples based on recent sales of comparable assets
Explain the Asset-Based Approach in private company valuation….
Values a firm’s assets minus its liabilities
Explain the Capitalized Cash Flow method…
A single measure of economic benefit is divided by a capitalization rate to arrive at firm value, where the capitalization rate is the required rate of return minus a growth rate
What factors require adjustment when estimating the discount rate for private companies?
- Size premiums
- Availability and cost of credit
- Acquirer versus target
- Projection risk
- Lifecycle stage
Given the below data, calculate CAPM, Expanded CAPM and the Build-Up method…
Risk Free Rate = 3.6%
Equity Risk Premium = 6%
Beta = 1.3
Small Stock Premium = 3%
Company Specific Risk Premium = 2%
Industry Risk Premium = 1%
CAPM = 3.6%+1.3(6%) = 11.4%
expanded CAPM , a small stock premium and company specific risk premium is added
= 3.6%+1.3(6%)+3%+2%=16.4%
Build METHOD, beta is omitted from the expanded CAPM but an industry risk premium is added
=3.6%+6%+3%+2%+1%=15.6%
What are the 3 Market approach methods for valuing a private company?
- Guideline Public Company Method (GPCM) - uses price multiples from trade data for public companies, with adjustments to the multiples to account for differences between the subject firm and the comparable
- Guideline Transactions Method (GTM) -prior acquisition values for entire /public and private) companies that already reflect any control premiums are used, so no controllig interest adjustment is necessary
- Prior Transactions Method - uses transactions data from the stock of the actual subject company and is most appropriate when valuing minority interests
When estimating a control premium, what factors should be considered?
- Transaction type- if strategic the price will be higher than if it is mearly a financial transaction
- Industry conditions- if there has already been a flurry of industry acquisition activity,the company may already reflect some premium for control. Adding more of a premium may overstate its value
- Type of consideration- Is it cash or stock for the deal? Is the company being purchased with “overvalued” shares?
- Reasonableness- Does the valuation make sense? Was it already overvalued and an additional control premium isn’t warranted….
When using multiples from historical transactions for the Guideline Transaction Method (GTC), what issues should be considered?
- Transaction type
- Contingent consideration
- Type of consideration
- Availability of data
- Date of data
Describe the asset based approach to private company valuation…
estimates the value of firm equity as the fair value of its assets minus the fair value of its liabilities. It is generally not used for going concerns.
When might the asset-based approach be appropriate to use?
- firms with minimal profits and little hope for better prospects
- finance firms like banks, where their asset and liability values can be based on market prices
- Investment firms such as REITs and Closed End Fund firms
- small companies or early stage companies with few intangible assets
- natural resource firms where assets can be valued using a comparable of sales
How do you determine the discount for lack of control (DLOC) of a company?
Explain the Discount for Lack of Marketability (DLOM)….
If the position cannot be easily sold, there will be a discount because of its lack of marketability. It is often the case that if there is a DLOC there will also be a DLOM
What are some examples of what would increase or decrease the Discount for Lack of Marketability (DLOM)?
Increase
- Greater risk and value uncertainty
- Contractual restrictions on selling stock
Decrease
- an impending IPO or firm sale
- the payments of dividends
- earlier, higher payments (ie shorter duration)
- a greater pool of buyers
What are the 3 methods an analyst can use to estimate a DLOM?
- The price of restricted shares is used.
- The price of pre-IPO shares is compared to the post-IPO price
- estimate the DLOM as the price of a put option divided by the stock price,where the put used is at the money
If there is a DLOC of 20% and a DLOM of 13%, what is the total discount???
they are multiplicative, not additive!!!
= 1- [(1-DLOC)(1-DLOM)]
=1-(0.8*0.87)
What are some of the challenges involved with the implimentation of appraisal standards in valuing private businesses?
- Compliance with these standards is usually at the discretion of the appraiser because most buyers are unaware of them
- since most valuation reports are private, it is very difficult for organizations to ensure compliance to the standards
- valuation will depend on the definition of value used
Calculate the normalized EBIT for both a financial and strategic buyer based on the information below…..
Reported EBITDA $6,700,000
Current Executive Compensation $800,000
Market Based Executive Compensation $650,000
Current SG&A expenses $8,100,000
SG&A expenses after synergies $7,300,000
Current lease rate $200,000
Market Based lease rate $250,000
**Financial Buyer: ** Will reduce the exec compensation but pay the higher lease rate
= 6,7000,000 +(800,000-650,000)-(250,000-200,000)
= 6,700,000 + 150,000 - 50,000
= 6,800,000
_Strategic Buyer: _Will reduce the exec compensation but pay the higher lease rate and also include the benefit of SG&A synergies
= 6,7000,000 +(800,000-650,000)-(250,000-200,000) + (8,100,000-7,300,000)
=6,7000,000+150,000-50,000+800,000
=$7,600,000
Given the following figures, calculate the FCFF. Assume the earnings are normalized and that capital expenditures will equal depreciation + 4% of incremental revenue
Current Revenues: $10,000,000
Revenue Growth : 5%
Gross Profit Margin: 20%
Depreciation Expense as % of sales : 1%
Working Capital as % of sales : 12%
SG&A expenses : $1,600,000
Tax Rate : 40%
Revenue 10,500,000 <- (10,000,000*1.05)
COGS 8,400,000 <- (10,500,000*0.80)
Gross Profit 2,100,000
SG&A 1,600,000
Pro Forma EBITDA 500,000
Deprec and Amort 105,000 <– (10,500,000*1%)
Pro Forma EBIT 395,000
Pro Forma taxes on EBIT 158,000 <- (395,000*40%)
Operating Income AT 237,000
FCFF Adjustments:
Plus : Depr and Amort 105,000
Minus: Capital Exp 125,000 <- (105,000 + (10,500,000*4%)
Minus: Increase in Work Capital 60,000 <-(.12 * (10,500,000-10,000,000))
FCFF = 157,000
Using the following figures, calculate the value of equity using CCM (Capitalized Cash Flow Methold), assuming the firm will be acquired,
Normalized FCFE CY : $2,200,000
Reported FCFE CY: $1,800,000
Growth rate of FCFE : 6%
Equity Discount Rate: 18%
WACC : 14.5%
Risk Free Rate: 4.2%
Cost of debt: 11%
MV of Debt
value of equity = FCFE1/r-g
**so we need to esitmate FCFE at Yr 1, then plug in the remaining #s
Using the following figures, calculate the value of the firm using the EEM ( Excess Earnings Method) …..
Working Capital : $400,000
Fixed Assets : $1,800,000
Normalized Earnings : $235,000
Required return on working capital : 4%
Required return on fixed assets : 12%
Growth rate of residual income : 3%
Discount rate for intangible assets : 16%
Step 1 : Calculcate required return for working capital and fixed assets
Fixed Assets = (1,800,000 * 12%) = 216,000
Working Capital = (400,000 * 4%) = 16,000
Step 2 : Calculate Residual Income
residual income = 235,000- 216,000 - 16,000 = 3,000
Step 3 : Value the intangible assets using the formula for a growing perpetuity
= (3,000 * 1.03) / (0.16-0.03) = 23,769
Step 4 : Sum the asset values to arrive at total firm value
= 400,000+1,800,000+23,769 = 2,223,769
An analyst is valuing a private firm on the behalf of a strategic buyer and deflates the average public co multiple by 30% to account for the higher risk of a public firm. Given the following, calculate the value of firm equity using the GPCM
Market value of debt : 2,600,000
Normalized EBITDA : 27,100,000
Average public co MVIC/EBITDA : 9.0
Control Premium from past transaction: 25%
Step 1 : Adjust the MVIC/EBITDA multiple
9.0 * (1-0.30) = 6.3
Step 2 : Use adjusted multiple against normalized EBITDA
6.3 * 27,100,000 = 170,730,00
Step 3 : Subtract out the debt to determine equity value
170,730,000 - 2,600,000 = 168,130,000
Step 4 : Since is a strategic buyer, add control premium
168,130,000 * (1.25) = 210,162,500
When using the Capitalized Cash Flow Model (CCM), do you use the normalized or reported free cash flow figures in the equation?
NORMALIZED
When using the Excess Earnings Model (EEM), should book value of assets or fair value of assets be used in the equation?
FAIR VALUE
