Valuation of private companies has application and necessity in both public and private equity world. While private companies need to come up with a rational valuation figure to convince venture investors for additional funding, public companies also consider acquiring private start-ups and thus have a keen eye on the outcome of the valuation of these private companies. Therefore, while an accurate valuation remains as a day-to-day agenda for private equity firms and also for the investors that are demanding transparency in the valuation process, still, the valuation of private companies remains a challenge given market volatility and scarcity of transactions. While many analysts cite independent oversight and continual documentation of transactions undertaken by these companies as the solution to the challenges in private company valuation, however, still there are numerous factors that continue to impede the valuation process. Below we have discussed some of the common challenges faced while valuation of a private company:
a)Finding comparable companies
One of the popular method of valuation of a private company is the Guideline Public Company Method (GPCM) as part of which, price multiples of comparable public companies are used to account for differences between the subject private firm and the comparables. While there might be numerous public companies with similar business operations as the subject private company, however, whether the data is comparable, that is still a big challenge. For instance, a new e-commerce tech start-up cannot be valued using the transaction data from Amazon, which happens to be the biggest publicly listed e-retailer in the world.
b) Calibrating the relevant liquidity and control discounts
At the time of valuation of private companies, adjustments are required when the liquidity and control position of private company differs from that of a comparable public company. For instance, if the comparable firm transaction data are for the purchase of an entire public company and the analyst is only willing to value a minority stake in the subject firm, he would be required to apply discount for lack of control and also for the lack of marketability, i.e liquidity. However, this process is not easy and requires high subjectivity as the variability of the estimated discount factor depends on numerous factors, such as interpretation of the data by the analyst and appropriate discount he seems just, importance of perceived position, allocation of shares and resulting effect on control, et cetera. Accordingly, each analyst may come up with different level of liquidity and control discounts.
c) Other issues
Discounted cash flow is yet another popular method for valuation of private companies as part of which, analyst use target's publicly-traded peers and estimate the value based on target’s discounted cash flow. However, this also includes numerous challenges as the growth of private company’s revenue may be completely different than that of comparable public company owing to lifecycle stage. Similarly, expenses of private companies are also different as these firms do not follow accounting standards as stringent as a public firm. Therefore, the analyst always face challenges reconciling these differences appropriately.
Conclusion
Therefore, from the above discussion it is clear that due to lack of regulatory oversight, the valuation of private equity still remains a challenge and this is majorly attributed to the opaque information available for these entities and also because of subjectivity involved in their valuation.
References
Dimech-DeBono, J. (2015, September). Valuation challenges in the private equity industry. Retrieved July 11, 2016, from http://www.financierworldwide.com/valuation-challenges-in-the-private-equity-industry/#.V4OYR9J961t
Investopedia. (2016). Valuing Private Companies. Retrieved July 11, 2016, from Investopedia: http://www.investopedia.com/articles/fundamental-analysis/11/valuing-private-companies.asp
Pearce, J. (2012). The challenges of private equity valuation. Ogier Fund Services.
