Determining the market value of a publicly-traded company can be done by multiplying its stock price by its outstanding shares. That's easy enough. But the process for private companies isn't as straightforward聽or transparent. Private companies聽don't report their financials publicly, and聽since there's no stock listed on an exchange, it's often聽difficult to determine the value for聽the company. Continue reading to find out more about private companies and some of the ways in which they're valued.

Key Takeaways

  • Determining the value of public companies is much easier than private companies which don't make their financials available to the public.
  • You can use the comparable company analysis approach, which involves looking for similar public companies.
  • nba腾讯体育直播ing findings from a private company's closest public competitors, you can determine its value by using the EBIDTA or enterprise value multiple.
  • The discounted cash flow method requires estimating the聽revenue growth of the target firm聽by averaging the revenue growth rates of similar companies.聽
  • All calculations are based on assumptions and estimations, and may not be accurate.

Why Value Private Companies?

Valuations are an important part of business, for companies themselves, but also for investors. For companies, valuations can help measure their progress and success, and can help them track their performance in the market compared to others. Investors can use valuations to help determine the worth of potential investments. They can do this by using data and information made public by a company. Regardless of who the valuation is for, it essentially describes the company's worth.

As we mentioned above, determining the value of a public company is relatively simpler compared to private companies. That's because of the amount of data and information made available by public companies.

Private vs. Public Ownership

The most obvious difference between privately-held and publicly-traded companies is that public firms have sold at least a portion of the firm's ownership聽during an initial public offering (IPO). An IPO聽gives outside shareholders an opportunity to purchase聽a stake in the company or equity聽in the form of stock. Once the company goes through its IPO, shares are then sold on the secondary market to the general pool of investors.

The ownership of private companies, on the other hand,聽remains in the hands of a select few shareholders. The list of owners typically includes the companies' founders, family members in the case of a family business, along with initial investors such as angel investors or venture capitalists. Private companies don't have the same requirements as public companies do for accounting standards. This makes it easier to report than if the company went public.聽


Valuing Private Companies

Private vs. Public Reporting

Public companies must adhere to accounting and reporting standards. These standards鈥攕tipulated by the Securities and Exchange Commission聽(SEC)鈥攊nclude reporting聽numerous filings to聽shareholders聽including annual and聽quarterly earnings reports and notices of insider聽trading activity.

Private companies are not bound by such stringent regulations. This allows them to conduct business without having to worry so much about SEC policy and public shareholder聽perception. The lack of strict reporting requirements聽is one of聽the major聽reasons聽why private companies聽remain private.

Raising Capital

Public Market

The biggest advantage of going public is the ability to tap the public financial markets聽for capital by issuing public shares or corporate bonds. Having access to such capital can allow public companies to raise funds to take on new projects or expand the business.

Owning Private Equity

Although private companies are not typically accessible to the average investor, there are times when private firms聽may need to raise capital. As a result, they may need to sell part of the聽ownership in the company.聽For example, private companies may elect to offer employees the opportunity to purchase stock in the company聽as compensation by聽making聽shares available for purchase.

Privately-held firms may also聽seek capital from private equity investments and venture capital. In such a case, those investing聽in a private company must be able to estimate the firm's value before making an investment decision. In the next section, we'll explore some聽of the聽valuation methods of private companies used by investors.

Comparable Valuation of Firms

The most common way to estimate the value of a private company is to use comparable company analysis (CCA). This approach involves searching for publicly-traded companies that聽most closely resemble the private or target firm.

The process includes researching companies of the same industry, ideally a direct competitor,聽similar size, age, and growth rate. Typically,聽several聽companies in the聽industry are identified that are similar to the target firm. Once an industry group is聽established, averages of their valuations or multiples can be聽calculated to provide a sense of where the private company fits within its industry.聽聽聽

For example, if we聽were trying to value聽an equity stake in a mid-sized apparel retailer, we聽would look for public聽companies of similar size and stature with the聽target firm. Once the peer group is established, we would calculate the industry averages including聽operating margins, free-cash-flow and sales per square foot鈥攁n important metric in retail sales.

Private Equity Valuation Metrics

Equity valuation metrics must also be collected, including price-to-earnings, price-to-sales, price-to-book, and聽price-to-free cash flow. The聽EBIDTA聽multiple can help in聽finding the target firm's聽enterprise value (EV)鈥攚hich is why it's also called the enterprise value multiple. This provides聽a much more accurate聽valuation because it includes debt in its value calculation.

The enterprise multiple is calculated by dividing the enterprise value by the company's earnings before interest taxes, depreciation, and amortization (EBIDTA). The company's enterprise value is sum of its market capitalization, value of debt, (minority interest, preferred shares subtracted from its cash and cash equivalents.

If the target firm operates in an industry that has seen recent acquisitions, corporate mergers, or IPOs, we can use the financial information from those聽transactions to calculate a聽valuation. Since聽investment bankers and corporate finance teams have already determined the value of the target's closest competitors, we can use their findings to analyze companies聽with聽comparable market聽share聽to come up with an estimate of the target's firm's valuation.聽

While no two firms are the same, by consolidating and averaging the聽data from the comparable company analysis,聽we can determine how the target firm compares to the publicly-traded peer group. From there, we're聽in a better position聽to聽estimate聽the target firm's聽value.聽

Estimating Discounted Cash Flow

The discounted cash flow聽method of聽valuing a private company, the discounted cash flow of similar companies in the peer group is calculated and applied to the target firm. The first聽step involves estimating the聽revenue growth of the target firm聽by averaging the revenue growth rates of the companies in the peer group.聽

This can often be a challenge for private companies due to the company's stage in its lifecycle and management's accounting methods. Since private companies are not held to the same stringent accounting standards as public firms, private firms' accounting statements often differ significantly and may include some personal expenses along with business expenses鈥攏ot uncommon in smaller family-owned businesses鈥攁long with owner salaries, which will also include the payment of dividends to ownership.

Once revenue聽has聽been estimated, we can estimate聽expected changes in operating costs, taxes and working capital. Free cash flow can then be calculated. This provides聽the operating cash聽remaining after capital expenditures聽have been deducted. Free cash flow is typically used by investors to determine how much money is available to give back to shareholders in, for example, the form of dividends.

Calculating Beta for Private Firms

The next step would be to calculate the peer group's聽average beta,聽tax rates, and debt-to-equity (D/E) ratios. Ultimately, the weighted average cost of capital (WACC) needs to be calculated. The WACC聽calculates聽the average cost of capital whether it's聽financed through debt and聽equity.

The cost of equity can be estimated using the Capital Asset Pricing Model (CAPM). The聽cost of debt will often be determined by examining the target's credit history to determine the interest rates being charged to the firm. The capital structure details including the debt and equity weightings, as well as the聽cost of capital from the peer group also need聽to be factored into the WACC聽calculations.

Determining Capital Structure

Although determining the target's capital structure can be difficult, industry averages can help in the calculations. However, it's聽likely that the costs of equity and debt for the private firm will be higher than its publicly-traded counterparts, so slight adjustments may be required to the average corporate structure to account for these inflated costs. Often, a premium is added to the cost of equity for a private firm to compensate for the lack of liquidity in holding an equity position in the firm.

Once the appropriate capital structure has been estimated, the WACC can be聽calculated. The WACC聽provides聽the discount rate聽for the target firm so that by聽discounting the target's estimated cash flows, we can establish聽a fair value聽of聽the private firm. The illiquidity premium, as previously mentioned, can also be added to the discount rate to compensate potential investors for the private investment.

Private company valuations may not be accurate because they rely on assumptions and estimations.

Problems With Private Company Valuations

While there may be some valid ways we can value private companies, it isn't an exact science. That's because these calculations are merely based on a series of assumptions and estimates. Moreover, there may be certain one-time events that may affect a comparable firm, which can sway a private company's valuation. These kind of circumstances are often hard to factor in, and generally require more reliability. Public company valuations, on the other hand, tend to be much more concrete because their values are based on actual data.

The Bottom Line

As you can see, the valuation of a private firm is full of assumptions, best guess estimates, and industry averages. With the lack of transparency聽involved in privately-held companies, it's聽a difficult task to place a reliable value on such businesses. Several other methods exist that are used in the private equity industry and by corporate finance advisory teams to determine the聽valuations of private companies.