1

VALUING PRIVATE FIRMS So far in this book, we have concentrated on the valuation of publicly traded firms. In this chapter, we turn our attention to the thousands of firms that are private businesses. These businesses range in size from small family businesses to some that rival large publicly traded firms. The principles of valuation remain the same, but there are estimation problems that are unique to private businesses. The information available for valuation tends to be much more limited, both in terms of history and depth, since private firms are often not governed by the strict accounting and reporting standards of publicly traded firms. In addition, the standard techniques for estimating risk parameters (such as beta and standard deviation) require market prices for equity, an input that is lacking for private firms.

When valuing private firms, the motive for the valuation matters and can affect the value. In particular, the value that is attached to a publicly traded firm may be different when it is being valued for sale to an individual, for sale to a publicly traded firm or for an initial public offering. In particular, whether there should be a discount on value for illiquidity and non-diversifiable risk or a premium for control will depend upon the motive for the valuation. We will consider each of these components over the course of this chapter.

What makes private firms different? There are a number of common characteristics shared by private firms with publicly traded firms, but there are four significant differences that can affect both how we estimate inputs for valuation. • Publicly traded firms are governed by a set of accounting standards that allow us to identify what each item in a financial statement includes but to also compare earnings across firms. Private firms, especially if they are not incorporated, operate

2 under far looser standards and there can be wide differences between firms on how items are accounted. • There is