Private company valuation is not an entirely objective matter. Subjective estimates, influenced by motivations and incentives, may alter valuation outcomes. One might need to value a private company for the following reasons:
A sale To raise capital from investors As part of a divorce settlement For a management buyout For estate planning For an employee stock ownership plan (ESOP) For taxation purposes
Other factors that may influence a private company’s valuation are its size, operating history, management and operational control, quantification of earnings and cash flow, capital structure, business risk, and breadth of liquidity in the market for private company’s stock.
Lack of Market Liquidity—The lack of liquidity discounts the value of a private company by as much as 50% since there is no benchmark for valuing private companies daily. Most commonly, a liquidity discount of 20-30% is applied. Size—Privately-held companies are generally much smaller than their publicly-traded comparables. Small private companies may be good acquisition targets for larger competitors and publicly-traded counterparts.
Operating History—Operating history is important to determine a track record for revenue growth, profitability and earnings growth. The less operating history a private company has the greater the risk for inconsistent cash flows, which leads to a greater valuation discount. Business Mix—Depending on whether a private company operates within a niche or has a variety of product mixes can impact the valuation discount. Market share and product concentration add to business risk. Management Control—Private companies have a very small pool of shareholders who often act as managers. This limits the pool of talent that runs the private company. The lack of a succession plan placing the business at considerable risk. Family-controlled enterprises may have considerable internal conflict over operational control. These risks lead to increased valuation discounts.
Earnings Measurement—Public companies are managed to maximize earnings on a quarterly basis. Yet, private companies may be managed for tax minimization, long term growth, or cash flow. Different operational motives make it difficult to measure true earnings and cash flows of the private company. It is important to normalize financials when trying to value a private company to determine what the private company would be earning if it was operated as a public company. Capital Structure—Private companies, unlike public companies, do not have as broad access to capital and therefore are unable to be as selective of their funding sources. Public companies are able to choose from both equity and debt sources to minimize their cost of capital while private companies are primarily
Risk — Private companies are generally riskier than their public comparables, often due to: Internal Criteria—Private Companies tend to be smaller in size and may lack a demonstrable financial track record. External Criteria—May face risk of business concentration or competing in an expansive industry.