Privately held companies can be valued by peer-group comparisons with similar stock-exchange listed firms and through cash-flow analysis.
Such companies differ from public limited companies (PLCs) and other stock-exchange listed firms. They do not have quoted share prices or need to report financial results to investors.
Family-owned businesses sometimes shun the capital-raising opportunities presented by initial public offerings (IPOs). They may instead want to keep tight, long‐term control over the business and avoid the pressures of contending with institutional shareholders.
But, with no share price for us to look up, how do we go about valuing private companies?
Comparable company analysis
Perhaps the most straightforward approach to valuing private companies is the so‐called comparable company analysis technique. Valuation is based on a comparison with public listed companies that have similar characteristics or with companies recently acquired for which relevant data is available.
To make a viable comparison in this way, we require at least some financial information on the private company.
Having established the value of comparable companies – companies of similar size in the same industry – we can calculate average peer‐group multiples. This can use variables such as earnings, sales and cash flow.
For instance, if we have an estimate for the annual sales of a private company, we can use the peer‐group price‐to‐sales ratio to reach a valuation estimate.
As an example, this latter ratio would be calculated by dividing the peer group’s market capitalisation by their sales in the most recent year. We can also adjust the multiple used for our private company according to parameters such as growth and risk.
Along with comparing the privately held firm to similar public listed companies, we can measure value against similar privately held businesses that have been recently acquired. Such transactions often throw up a treasure trove of information that would otherwise be unavailable.
Cash‐flow analysis tends to play an important role in private business valuation, as it does in the valuation of public listed companies. The expected future cash flows of private businesses available to equity and debt holders can be used to calculate the enterprise value (EV).
Cash flows are discounted using a rate that reflects the time value of money (cash flows received in the future are worth less than they are today).
The rate used should also reflect the individual business’s risk, with this a function of both the company’s cost of equity and debt.