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Valuing Private Companies: Factors and Approaches to Consider. Presenter Venue Date. Public vs. Private Valuation: Company-Specific Differences. Public vs. Private Valuation: Company-Specific Differences. Public vs. Private Valuation: Stock-Specific Differences.
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Valuing Private Companies:Factors and Approaches to Consider Presenter Venue Date
Income Approach: Three Methods • Free Cash Flow • Based on the present value of future estimated cash flows and terminal value using a risk-adjusted discount rate • PV of expected future cash flows + PV of terminal value • Capitalized Cash Flow • Based on a single estimate of economic benefits divided by an appropriate capitalization rate • Residual Income (Excess earnings) • Based on an estimate of the value of intangible assets, working capital, and fixed assets
Excess Earnings Method • Residual income = • Normalized earnings – (Return on working capital) – (Return on fixed assets) • Value of intangible assets = • Value of the firm = • Working capital + Fixed assets + Intangible assets
Example: Excess Earnings Method • Return on working capital = 5% x $400,000 = $20,000 • Return on fixed assets = 12% x $1,600,000 = $192,000 • Residual income = $225,000 – $20,000 – $192,000 = $13,000 • Value of intangible assets = ($13,000 x 1.03) / (0.18 – 0.03) = $89,267 • Value of firm = $400,000 + $1,600,000 + $89,267 = $2,089,267
Discount Rate Estimation Issues Size Premiums • Size effect can increase discount rate Cost Debt • Relative availability may be limited increased cost of debt • Higher operating risk increased cost of debt Discount Rates in an Acquisition Context • Should be consistent with cash flows, not buyer’s cost of capital Projection Risk • Uncertainty associated with future cash flows Life Cycle stage • Classification, early stage difficulties, company-specific risk
Example: Guideline Public Company Method Public price multiple will be deflated by 18 percent • Due to increased risk of private firm If buyer is strategic • A control premium of 20 percent from previous transactions is applied If buyer is nonstrategic • No control premium is applied
Example: Guideline Public Company MethodStrategic Buyer Risk adjustment: 9.0 × (1 – 0.18) = 7.4 Control premium: 7.4 × (1 + 0.20) = 8.9 Value of firm: 8.9 × $28,000,000 = $249,200,000 Value of equity: $249,200,000 – $6,800,000 = $242,400,000
Example: Guideline Public Company MethodFinancial Buyer Risk adjustment: 9.0 × (1 – 0.18) = 7.4 The control premium is not applied Value of firm: 7.4 × $28,000,000 = $207,200,000 Value of equity: $207,200,000 – $6,800,000 = $200,400,000
DLOC Example Given a control premium of 19 percent
Valuation Discounts Given a DLOC of 20 percent & DLOM of 16 percent