Reading 24: Private Company Valuation

Page No 9715th Nov' 2022 ThuesdayDate / /Reading 24 PrivateCompany Valuation*Private Vs Public CompaniesCompany - SpecificStage of lifeccycle :- less Mature than publicSize :- Smaller than public lower Capital lower employees noOverlap of management : Managementarial Controland shareholderlong - term perspectiveQuality and dept of : Limited growth potentialManagementLess attractive to management CandidateLess Mgmt dept &fewer employeesRisk &growth prospects poteaVtDifinage- froqma) Page No. 98Date//Qualitity of financial : Pon't have to make disdosureand public other infouncertainity andRisklower ValuationShort-Term: Dont experiance short-term stock priceInvestorsNo performancepressurelong-termperspetiveTaxes: Greater tax concerns Ex private expbiz expStock - SpecificLiquidity : lessliquidity in equity interestsandnot traded on exchRestrictions haveliquidityon : restrictions on liquidity+ve forcentroling-ve for minorityConcentration of Control : Have concentration of control to possibledetermentofNon- controlling SHStock - -Specific :-We-VeCompany -Specific :- tVe or -Ve Page No. 99Date / /diversity.More Heterogeneity with privatefirms- Greatervarietyin risk-Greater varietyinvaluationmethodsReasons for Valuing Private CompaniesTransactions :VentureCapitalfinancingShare holders suitsLitigation :IPODamage claimsAcquisition / firm SaleLost profitsBankruptcyDivorcesStock - basedCompensationBy LawComplianceFinancing ReportingTaxesApproach to ValuationsIncome :DCFstoDozzAMarket : PIE-PV of future income- Price multiples of comparables-For high growth Co - FisticeFormaturecompanyAsset -based : Liquidation-Asset - LiabilityLife cycle stage should+For los in early stagebe Consideredof lifecycle Page No. 100Date //ValueFV for FR/Litig"Market ValueFMVused for tax purposesSimilar to FMVUsed in real estate& based on arm'sbut used for FRappraisals characterizelength transanctionby well informed failInvestmentsIntrasic ValueValue to a particularthe "true" value derivedbuyerfrom invt. analysisNormalized Earnings AdjustmentsVIMPand unusualitemsNon- recurringDiscretionaryexp - private exp as biz expNon - marketCom pensationlevel - Associate alched Mag" feesmgPersonalexpReal estateexpNot relevant RE7-Non marketlease ratesStrategicVs.Non-strategicbuyersbloods good slops q/id/gdSenergyies Page No. 101Date / /*Issues in CF Est707ScenarioControlling Vs non controlling interestsanalysis - Base Best Bad casesExchange disc fatelife cyclestageCearlylifestagehardtoevalulate t No historyManagement biasesCapitalstructurechanges(FCFF/FCFEUncertaintyMeg Mngtregarding future CFsbiasedsuchasover standing goodwillFCFF shouldbeusedwhensubstantialCapitalstructurechangesareanti cipatedInastrategictransactionvaluationofthet(wm basedfirmisonperceivedsynergies.A financial transactionsassumesnosynergies(whenonefirmsbuysanotherfirminadissimilarindustry)IncomeApproach MethodsStragtegic :IncorporateBuyeracqFCFsynergies- 2 stageCapitalized CF - Single stageFinancial: Does notExcess earningsBuyeralgmeConstand growth div modeCF,(r-g)Cap rate Page No.b2DateFCF MethodF.MostSuitableoftenusedforsmallprivatelos'whencomparablesareavailablesnoareusequiteuncertain,stablegrowthreasonableproject&assumptionslerPV (discreteCFsplusa terminal value)Terminal value- Constantgrowthmodel- Price -multipleapproachPotentialdoubleCountingofhighgrowthdontuseCurrentGitassumeValue of firmshighgrowthin=FCFF,futurebirrolWACC = gValueofEquity=FCFEr-g -CapitalizedCFMethod afortzSinglestageFCFmodelDirect Capitalizations =CFdisc rate -growth Page No. 103Date / /V. firm = FCFFVo equity =FCFE.WALL - -gr-gExcess earnings methods IMP - Dont apply for to value equityGoodwill valuation-for Intangible assets11Calculate earnings based on req return on WC &fixed assetsEquity chargey2Calculate excess earnings ( firm earnings - earnings based on )req return3Calculate PV of excess earnings ( equals value of intangible assetsPV of RI4Calculate the value of Company (wc + Fixed assets ) t PV ofexcess earningsSuitable for firms with significant intangible assetsFirm's earnings : Earnings reg to provides the req rate of returnon we & Fixed assetsThis Can then beused to est the value of intangilassetsas 4 of growing stream of excess earningsValue of = Fixed Asset + WC + Intangible AssetsfirmsThis methods is used for smaller firms when theirintangible assets are significants MV of Invested Capital = WC +FC + IntangiblePage No. 104Date/Don't Consufe with RT methodExampleMV of Invested = 300,000 +1000,000 7 190capitalWorking Capital - 300,000 XFixed asset - 1,000,000 x 10%Normalized earnings lyr just To ended) - 130,000uReq return for WC-&6% Jonty in excess earningsReq retuin for FC10%IGrowth rate of RI -5%Disc rate for intangible assets - 14%Sol'Return on ww.wc = 300,000 X 6%=18,00Retuin on FC = 1,000,000 X10%= 100,000aldutinaNIlikRI = 130,000 - 18,000 - 100,000=12,000 -> To theFC1tgValue of intangible assets=12,000X1.05(0.14 -0.05)rg=140,000 VALUE INTangibleweValue of firms = 300,000 + 1000,000 t 140,000MV of Ind Invested = 1,440,000Fix CINTCapita Build-up Rf + ERP + Small stock prem t Company specific Risk premtApproachIndustry Risk premPage No. 105Date//Disc Rate Est ElementsSize premProjection RiskAvailability & lost of debtLife cycle stageAcq VS targetuse thisifsmall Cant get good rate and optional debt*Disc Rate ModelsCAPMSAppropriate for small private Companies that have littleChance of going public or being acq byapublic companyNot appropriate for some firms asBetaisestfrompublicfirm'sreturnsusuallyExpanded CAPM Allow to adj for extia fiskIncludes additionalpremiumsforsix e&firmsspecific riskVersion of CAPM that includes prem for small Size &Company specific riskBuild-up ApproachUsed when guideline public Companies are not availableSimilar to expanded CAPM except that the beta isassume to be oneWhenit is not possible to find the compareable publicfirms for B estof firm is aig use optimal Cup staitsum stinterrod Page No. 106Date/.Possible $ risk prem :- SizeF- Company - specific Risk- Industry riskusEst WACC&IsCurrent Vs optimal Capital structurePublic VS private firms debt capacity andlostMarketAsuas CardApproachAdvantage - Plenty of dataministry Guideline Public Company Method C GPCM yDisadvantage - Data may not be ComparableRelative multiples are derived and adj for diffControl prem are used when valuing controlling Intsubject company and Comparable public companyCompany ( adj are made only to the equity portion)Usesprice multiples from trade data for publicCo'swithadj Make to multiples to Alc for risk the diffadj to a/c for extraControl= Pro rata value of- pro rata valuepremcontrolling interestof NCIA financial transaction typically has a smaller premAdj Control = Control prem X Cl- DR)Premof equityMVapplicable forMultipledebt to asset RatioC Page No. 107Private firm data may not be available or Date//accurateGuideline Transactions Method (GTM)Price multiples are derived from past acq of privateor public companies Adj of RiskTransactions already reflect control prem t therefore thereisnoneedforadditionaladjFactors to consider when issuing multiplesfromhistorical transaction :-transaction typeContingent considerBest when:Type of consider1 Valving minority IntAvailability of data- Data is arms - lengthdate of data- Data is of same motivation- Data is recentPrior Transaction Method (PTM)This method considers actual transaction inthe stockof the subject Company(NCV).Most relevant whenvaluingnon controlling (minority) Int.Uses Historical sales data from subject firmEx : GPCMReduce valueRecent tran" was prem of 30 %NidiscSmaller than Comparable GPC higher risk (Risk prem defator = 20%)MV of debt 1,100,000INormalized EBITDA Invested capital 12,800,000Avg MVIC-multiple8.0X 1-0.2)6.4EBITDACalculate pure Investment (non - synergistic) Acq value Page No. 108DateSolnTakeoverpremF . Adjforthis valuationprobablyrelatedtosynergiesnotrepMVICmultiple=8 (1-0-20)EBITDA=6.40use.&Firm value=6.4 x12,800,000le= 81,920,000MV of debtValue of Equity81,920,000 - 1,100,000=80,820,000GPCMEquity = Firm - debtControl prem Issues- Transaction type- Industry Conditions- Type of Consideration stock Contigent consideration- ReasonablenessBardwood or anet,AssetBased Approach (Cost approach)Value of Company = FV of assets - FV of liabilitiesConsideredweakestofthethree apprachesUsually the lowest valuationsRarely used for valuation of going Concernsm Totake22=18%short cut102122Page No. logDate / /Firmswithminimalprofits&littlehopeforbetterpropectsCan be used for:- Troubled firms- Firms with few intangibles- Finance firms- Naturalresource firms- Investment CompaniesGold mine, oil reserveDifficults in valuations- Individual assets- Specialized assets22/ = 187- Intangibles=0122Valuation DiscountDisc for LackofControl (DLOC)Controlling share holderscanenjoyexcessivecompensationandotherperqueisitestothedetrimentofminorityShareholders.Firms likely likely to to pursue experience actions on that IPO damage of sale minority are SH. lessEst using reported earnings a Instead of normalizedearningsor:IAlwaysDLOC = 1-I + Control PremControl prem > DLOCif Control prem is 227.stibingDLOC = 1-140-22111318.0% Page No. 110Date/Using Control Prem &DiscFComparables DataSubject ValuationsAdj to ComparableControlling IntControlling IntNoneus&leControlling IntNon - Centrolling IntDLOCNon Controlling IntControlling IntControl premNon controlling IntNon controlling IntNoneDLOM Varies withApplied whenDisc for lack of MarketibilityintinafirmcannotbeeasilysoldVaries with :-- Likelihood of IPO T firm sale , or div- Asset durationsliq1Disc- ContractualrestrictionsliqDisc- Pool ofbuyersTliqDisc- Asset riskliqilliquidelefromDiscLiquitatityEst of DLOM- Restrictedvs publictradedshares-Pre - IPOVspost IPOpricesPut pricesAdvantage: est Risk of-alilliquiditythe firm can beDLOM fadored into theElitiquidityDLOM option price Page No. IIIDate / /Factors affectingDLOMImpendingIPol firmsalewouldDLOMPay"ofdivwouldDLOMEarlier ,higherpay"wouldDLOMContractualrestrictionsonsellingstockwouldDLOMGreaterpool of buyerswouldDLOMGreaterrisk & valueuncetainty wouldtheDLOMTotal Disc=1-[CDLOC) (1-DLOM) ]ExofApplyingDisc / Prem(ST.(COM)(1-005)Minority SH (15% owner) given that :- Scenario 1:CEO (majorityowner)wants to sell the firm soonatavalueof10MM ( DLOM of 57 ]- Scenario 2:Noimminent Sale ( DLOM of 207.) i equity valuedat$ 9MM Cafter DLOC) using earnings methodValuethe minority int (after applying disc /prem) in each ScenarisSolnScenario I :- DLOM of 5% is applied to sale value (no DLOC) of$10MM- Value = (0-15) ($10MM) (1-0.05)= 1,425, 000 Page No.112Date/Scenario 2 :- DLOM of 20% is applied to value after DLOCisa- Value = (0.15) ( ($4MM) (1-0.2)appl1,080 ,000us&ColeProjection earningsNoItreferstotheriskGritonofmisestimatingfutureCFNc100DLOC =15%X0.85DLOM 20°0.832 disc6.8