The Scope of Private Company Valuation

Company-specific Factors

1. Stage in the Lifecycle

   Private companies are usually at the early stage of development, while public companies are normally advanced in their lifecycle. Private companies have fewer employees and lower assets but may be significant, stable, and failed companies in liquidation. The lifecycle stage influences the valuation process.

2. Size

   They are measured by its income statement or balance sheet. Private companies tend to be smaller in size. The smaller size increases risk levels and risk premiums when estimating required returns. The small size of private companies reduces their access to capital to fund the growth of operations. However, the cost of operating as a public company, including compliance costs, may outweigh the financing benefits that public companies may have.

3. Overlap of Shareholders and Management

   Many private companies have their top management controlling ownership in the companies. This mitigates agency issues. Private companies do not have pressure from external investors for short-term results; therefore, their decisions have a longer-term perspective.

4. Quality/Depth of Management

   Private companies have lower quality and depth of management as they are less likely to attract highly skilled managers than public companies.

5. Quality of Financial Information

   Public companies are required to make timely disclosure of financial and other information. Analysts also place demands on management for high-quality information. The less demand placed on private companies’ disclosure of financial information increases risk and leads to a relatively lower valuation.

6. Pressure from short-term Investors

   Top management of public companies faces pressure from investors and analysts to take actions that will achieve short-term expectations. Management of private companies does not face similar pressure, and therefore, their actions take a longer-term perspective.

7. Tax Concerns 

   Reducing reported taxable income and corporate tax payments may be a more important goal for private companies than public companies because of greater benefit to the owners.

Stock-specific factors

1. Liquidity of Equity Interests in Business

   Private company stock is usually less liquid and has fewer shareholders than public companies. This reduces the value of shares in private companies compared to public companies.

2. Concentration of Control

   The control of private companies is often concentrated in a few investors, which can lead to transactions with cross-owned entities at above-market prices, which can benefit majority owners at the expense of minority shareholders.

3. Potential Agreements Restricting Liquidity

   Private companies may have shareholder agreements that restrict the ability to sell shares. These agreements may reduce the marketability of the private company's shares.

   Stock-specific factors are negative for private company valuation, while company-specific factors are potentially either positive or negative.

Question

Which of the following is least likely a stock-specific difference between public and private companies?

1. Concentration of control.
2. Potential agreements restricting liquidity.
3. Stage in lifecycle.

Solution

The correct answer is C.

The stage in the lifecycle is a company-specific difference between public and private companies. Private companies are usually at the early stage of development while public companies are normally advanced in their lifecycle.

A is incorrect. The concentration of control is a stock-specific difference between public and private companies. Private companies have control concentrated on a few investors compared to public companies.

B is incorrect. Potential agreements restricting liquidity are a stock-specific factor differentiating public and private companies. Private companies may have shareholder agreements that restrict the ability to sell shares.

Reading 27: Private Company Valuation

LOS 27 (a) Contrast important public and private company features for valuation purposes