Private Company Valuation
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- Опубликовано: 26 июл 2024
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In this tutorial, you'll learn how private companies are valued differently from public companies, including differences in the financial statements, the public comps, the precedent transactions, and the DCF analysis and WACC.
Get all the files and the textual description and explanation here:
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Table of Contents:
1:29 The Three Types of Private Companies and the Main Differences
6:22 Accounting and 3-Statement Differences
12:04 Valuation Differences
16:14 DCF and WACC Differences
21:09 Recap and Summary
The Three Type of Private Companies
To master this topic, you need to understand that "private companies" are very different, even though they're in the same basic category.
There are three main types worth analyzing:
Money Businesses: These are true small businesses, owned by families or individuals, with no aspirations of becoming huge. They are often heavily dependent on one person or several individuals.
Examples include restaurants, law firms, and even this BIWS/M&I business.
Meth Businesses: These are venture-backed startups aiming to disrupt big markets and eventually become huge companies.
Examples include Kakao, WhatsApp, Instagram, and Tumblr - all before they were acquired.
Empire Businesses: These are large companies with management teams and Boards of Directors; they could be public but have chosen not to be.
Examples include Ikea, Cargill, SAS, and Koch Industries.
You see the most differences with Money Businesses and much smaller differences with the other two categories. The main differences have to do with accounting and the three financial statements, valuation, and the DCF analysis.
Accounting and 3-Statement Differences
Key adjustments might include "normalizing" the company's financial statements to make them compliant with US GAAP or IFRS, classifying the owner's dividends as a compensation expense on the Income Statement, removing intermingled personal expenses, and adjusting the tax rate in future periods.
These points should NOT be issues with Meth Businesses (startups) or Empire Businesses (large private companies) unless the company is another Enron.
Valuation Differences
The valuation of a private company depends heavily on its purpose: are you valuing the company right before an IPO? Or evaluating it for an acquisition by an individual or private/public buyer?
These companies might be worth very different amounts to different parties - they should be worth the most in IPO scenarios because private companies gain a larger, diverse shareholder base like that.
You'll almost always apply an "illiquidity discount" or "private company discount" to the multiples from the public comps; a 10x EBITDA multiple is great, but it doesn't hold up so well if the comps have $500 million in revenue and your company has $500,000 in revenue.
This discount might range from 10% to 30% or more, depending on the size and scale of the company you're valuing.
Precedent Transactions tend to be more similar, and you don't apply the same type of huge discount there for larger private companies.
You may see more "creative" metrics used, such as Enterprise Value / Monthly Active Users, especially for private mobile/gaming/social companies.
DCF and WACC Differences
The biggest problems here are the Discount Rate and the Terminal Value.
The Discount Rate has to be higher for private companies, but you can't calculate it in the traditional way because private companies
don't have Betas or Market Caps.
Instead, you often use the industry-average capital structure or average from the comparables to determine the appropriate percentages, and then calculate Beta, Cost of Equity, and WACC based on that.
There are other approaches as well - use the firm's optimal capital structure, create a giant circular reference, or use earnings volatility or dividend growth rates - but this is the most realistic one.
You use this approach for all private companies because they all have the same problem (no Market Cap or Beta).
You'll also have to discount the Terminal Value, but this is mostly an issue for Money Businesses because of their dependency on the owner and key individuals.
You could heavily discount the Terminal Value, use the company's future Liquidation Value AS the Terminal Value, or assume the company stops operating in the future and skip Terminal Value entirely.
Regardless of which one you use, Terminal Value will be substantially lower for this type of company.
The result is that the valuation will be MOST different for a Money Business, with smaller, but still possibly substantial, differences for Meth Businesses and Empire Businesses.
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this isnt an education dummy.. its a sales pitch
I learn more from this channel than from my finance career at college
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Thank you for this great tutorial!
I'm interviewing for IB and PE at the moment, and your resources really help.
Cheers
+Fayste69 Thanks for watching!
This is yet another great piece of finance education!
+Александр Вальцев Thanks for watching!
Really Well Explained Video.
This channel is helping my study for my final. Thank you 😊
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Once again, an excellent video! thx
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Thank you so much for your video. ^_^
quite applicable fopr Middle Market M&A players
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Do bankers use templates for modeling or they have to do everything from the scratch? For example, do they calculate Betas manaully or just connect the excel to Capital IQ?
Depends on the purpose of the analysis... you rarely calculate Beta manually, you almost always get it from Bloomberg.
Thanks
Thanks for watching!
For DCF problems @16.56, i know not having beta is a problem as you can't calculate cost of equity using CAPM, but why is not having market capitalization a problem? Great vid
Because you need the market capitalization to re-lever Beta based on the company's own capital structure (if you're calculating Cost of Equity that way rather than using the median capital structure of the comparable companies).
How do you determine the different multiples such as maximum multiple, 75th percent multiple as indicated in the ValSum tab of the workbook that you have for this video? Do you have a video explaining the methodology that you used to determine the multiples? Also, do you use the discount method and terminal value method to arrive at 2 different valuations and compare the final result from each method with each other? What is the point of determining terminal value method in private company valuation? Thanks you so much for your help!
You're asking about questions that are either beyond the scope of this tutorial or that have been covered elsewhere in this channel; please see the Valuation and DCF playlists or look up the lessons on Terminal Value to get answers to those questions. There is nothing special with determining the 25th percentile/75th percentile/median and so on - it's just simple statistics applied to the full range of multiples from comparable public companies.
Hi, great videos thank you. Just one quick point, 17:00 what do you mean by 'median "total" unlevered beta' of 1.93? How did you calculate it? Thanks!
Do a Google search for "Total Betas by Sectors" - it is based on an entire sector and its correlation to the market as a whole, since private companies do not have stock prices and stock trading histories.
Hi great video! Was wondering why did you not take the unlevered beta of 1.15 instead since you are comparing with its peers?
Is there anyway I can get a copy of the excel spreadsheet you used in the video?
Click "Show More." Click the link. Click again.
@Mergers & Inquisitions / Breaking Into Wall Street I have one more question. I was using this model for a canadian company but unfortunately there is no listed competitor in canadian stock exchane. So i used US based company for comparatives. In that case should i use risk free rate, market premium and cost of debt etc for canadian market or us based market ?
Risk-free rate should be based on the subject company's currency, but the market premium and cost of debt can be based on the comparables.
Could you please tell me what the mid year means when you discounted the cash flows ?
The mid-year convention means that we assume the cash flow arrives in the middle of the year rather than entirely at the end, to represent the fact that cash flow is generated over the course of the year - not just at the end. This is slightly more accurate than using the year-end convention.
what is the work flow involved in valuing a mining company that is not listed on the stock exchange?
You would use something similar to a NAV model... look at the company's total reserves, assuming a certain production level and production decline until the reserves are depleted, and then calculate and discount the cash flows from that production. If the company has land that it has not yet developed mines on, assume they do in future years and make that additional production influence the total as well.
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Thanks for watching!
In calculating debt to equity ratio , should the equity be balance sheet figure or market value?
Ideally the Market Value, but if you can't find it or estimate it in any way, you could just use the Book Value... and it's usually not a huge problem for smaller, private companies that sell for low valuation multiples anyway.
What would be the general EV or Mkt Cap range of a 'Meth' business compared to an ' Empire' business?
A true "small business" is generally worth $10 million USD or less, all the way down to the hundreds of thousands (or less). Large public companies are almost always worth at least $50 - $100 million and often a lot more than that. But private companies with the same setup could also be worth something in that range. Venture-backed startups could be worth almost anything, from low millions in the first funding round to billions or tens of billions shortly before going public (Lyft and Uber). But it's fair to say that the average legitimate, profitable, large private company is worth more than the average startup... outliers can skew this.
Great video! I understand that you said valuation for "empire" business will be discounted less than say "Money" business or "Meth" business, but how do we estimate the discount %? And I assume that we are discounting for both TV and Enterprise value.
There's no scientific way to do it. You could look at recent precedent transactions for private vs. public companies and estimate it like that (e.g., based on the % reduction in multiples), or you could base it on something like the "size premium" in the Cost of Equity and look at the percentage discount that extra premium implies when applied to the Discount Rate calculation.
I'm having a bit of trouble understanding why we wouldn't discount the precedent transaction multiples when valuing a private company. I get why we do discount the public company comps, since private companies are less liquid than public ones. By why would we not discount the precedent transactions multiples?
Because precedent transactions already reflect the control premium paid for the other company, regardless of whether the other company was public or private.
How can we calculate private co. Unleveraged beta using a industry's levered beta ???
Un-lever it based on the median capital structure percentages for comparable public companies in the same industry.
Can we still use WACC as the discount rate when the capital structure changes over the years?
Yes, you just have to change WACC over time and use a cumulative discount factor each year that factors in the changing WACC. WACC in the Terminal Period should represent what you expect the company's long-term capital structure to be, which should probably be close to the capital structure of peer companies.
@@financialmodeling Thanks so much! this is very helpful!
What do you mean by "Normalize the categories"? Converting them to GAAP?
Yes
How do you get forward year 1 and Forward year 2 revenue, EBITDA and NEt profit for public company ?
Look on Yahoo Finance, Bloomberg, Capital IQ, etc. to find consensus estimates. FinViz can also be helpful.
@@financialmodeling thank you very much !. I have one more question. I was using this model for a canadian company but unfortunately there is no listed competitor in canadian stock exchane. So i used US based company for comparatives. In that case should i use risk free rate, market premium and cost of debt etc for canadian market or us based market ?
Thanks for the video. How would one estimate the target firm's EBITDA
if it does not publish any information other than last year's revenue?
I'm stuck because I created the Peer Universe and calculated multiples,
but the only info published on the target is 2018's Revenue.
You can't do much. Maybe look at peer companies in the industry that are public and apply their margins to your company. Or gain access to something like Capital IQ, privco.com, etc. that lists private company information.
Mergers & Inquisitions / Breaking Into Wall Street Thanks for the prompt reply. I have access to PitchBook via my university which I have been using; however, I find for most of the private companies their EBITDA is not published.
I’m trying to make a “mock PitchBook” to show competency in IB interviews; would you have any suggestions on valuation? Or should I just try to find a private company who’s EBITDA is published?
I don't know, there are example valuations in this channel and elsewhere on the sites. You need some information to work with, so try to find a private company with at least some published information. Try picking a larger public company, like SAS Institute, with somewhat-known financial figures, rather than small businesses.
Mergers & Inquisitions / Breaking Into Wall Street Thank you!! You guys are incredible
Could have used this like 6 months ago during recruitment season lol
+Casimir III We created the tutorials and added them to our course in March 2015...
+Mergers & Inquisitions / Breaking Into Wall Street the video does an excellent job of explaining it though and would have ironed out flaws in my understanding. But yeah I read a lot of the site last year as well
What about small business with empire business revenue? Never sell business?
What is your question? Are you asking if you should never sell a business if it gets to a certain revenue level? I can't really answer that question because it depends on your goals and how much you want money now vs. future growth potential later. If you can get tens of millions of dollars and you really want to have a good life and not work, you should probably sell, even if you get a low multiple for the business. If not, or if you want to focus on work/career, you should probably not sell.
For example, a private small business that has a turnover of 100M profit year, with a cost of operation below 4M, no debt. How would you evaluate?
Again, your question is unclear so I have no answer. Are you asking how you would *value* that business? Or if you should sell it or keep running it? Even a business at that scale would not get a high multiple if it's highly dependent on its owner or a small group of people and can't be run by an outside management team with systems and processes.
If I understood correctly, for a private company that doesn't have a Beta, you'll look at the comparable's (public) capital structure, and then take the median of the comps' unlevered Beta, and use it as your Beta.
What if there were no comparables?!
Then you would need some other way to estimate Beta, such as looking at the company's earnings variance vs. the earnings of the S&P 500, or the targeted returns for your portfolio, or the industry-wide Beta, or something else like that.
Mergers & Inquisitions / Breaking Into Wall Street thanks. I'm wondering about PE, so does the SP500 would be a good benchmark?
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Hey, we try to be as international as possible...
@@financialmodeling Yeah, that's great! I have really enjoyed and learned a lot from your videos. Thank you!
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Spoilers man!