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Valuing Private Companies: Factors and Approaches to Consider

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

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  1. Valuing Private Companies:Factors and Approaches to Consider Presenter Venue Date

  2. Public vs. Private Valuation:Company-Specific Differences

  3. Public vs. Private Valuation:Company-Specific Differences

  4. Public vs. Private Valuation:Stock-Specific Differences

  5. Reasons for Private Equity Valuations

  6. Definitions of “Value”

  7. Private Valuation Approaches

  8. Earnings Normalization

  9. Example: Earnings Normalization

  10. Cash Flow Estimation

  11. 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

  12. Capitalized Cash Flow Method

  13. 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

  14. Example: Excess Earnings Method

  15. 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

  16. 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

  17. Required Rate of Return Models

  18. Example: Required Return Models

  19. Example: Required Return Models

  20. Market Approach: Three Methods

  21. Guideline Public Company Method

  22. Guideline Transactions Method

  23. Prior Transaction Method

  24. Example: Guideline Public Company Method

  25. 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

  26. 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

  27. 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

  28. Asset-Based Approach

  29. Valuation Discounts/Premiums

  30. DLOC Example Given a control premium of 19 percent

  31. Valuation Discounts

  32. Valuation Discounts Given a DLOC of 20 percent & DLOM of 16 percent

  33. Valuation Standards

  34. Summary

  35. Summary

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