2. Market prices to compute the value of options and warrants granted to employees . Market value as output : When valuing publicly traded firms, the market value operates as a measure of reasonableness. In private company valuation, the value stands alone. Market price based risk measures , such as beta and bond ratings, will not be available for private businesses.
Aswath Damodaran 162 2. Cash Flow Estimation Issues Shorter history : Private firms often have been around for much shorter time periods than most publicly traded firms. There is therefore less historical information available on them. Different Accounting Standards : The accounting statements for private firms are often based upon different accounting standards than public firms, which operate under much tighter constraints on what to report and when to report. Intermingling of personal and business expenses : In the case of private firms, some personal expenses may be reported as business expenses. Separating “ Salaries ” from “ Dividends ” : It is difficult to tell where salaries end and dividends begin in a private firm, since they both end up with the owner.
Aswath Damodaran 163 Private Company Valuation: Motive matters You can value a private company for • ‘ Show ’ valuations – Curiosity: How much is my business really worth? – Legal purposes : Estate tax and divorce court • Transaction valuations – Sale or prospective sale to another individual or private entity. – Sale of one partner ’ s interest to another – Sale to a publicly traded firm • As prelude to setting the offering price in an initial public offering You can value a division or divisions of a publicly traded firm • As prelude to a spin off • For sale to another entity • To do a sum-of-the-parts valuation to determine whether a firm will be worth more broken up or if it is being efficiently run.
Aswath Damodaran 164 Private company valuations: Three broad scenarios Private to private transactions : You can value a private business for sale by one individual to another. Private to public transactions : You can value a private firm for sale to a publicly traded firm. Private to IPO : You can value a private firm for an initial public offering. Private to VC to Public : You can value a private firm that is expected to raise venture capital along the way on its path to going public.
Aswath Damodaran 165 I. Private to Private transaction In private to private transactions, a private business is sold by one individual to another. There are three key issues that we need to confront in such transactions: 1. Neither the buyer nor the seller is diversified . Consequently, risk and return models that focus on just the risk that cannot be diversified away will seriously under estimate the discount rates.
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