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CFA® Level II · Equities · free lesson
Private Company Valuation
Most companies are private, and they are valued constantly: for acquisitions, financings, tax returns, financial statements and court cases. This module explains how private companies differ from public ones, normalises their earnings, estimates their cost of capital with the expanded CAPM and build-up methods, applies income, market and asset-based approaches, and converts a control value into the value of a minority stake with discounts for lack of control and marketability. Level II vignettes chain these steps, so the order of adjustments matters as much as the arithmetic.
What you will learn
1. Contrast the company-specific and stock-specific characteristics of private and public companies that matter for valuation, and describe the reasons private companies are valued and the definitions of value used.
- Private companies: earlier stage, smaller, owner-managers, weaker information, less short-term pressure, tax-driven decisions.
- Private shares: illiquid, transfer restrictions, concentrated control.
- Reasons: transaction-related, compliance-related (financial reporting, tax) and litigation-related.
- Definitions: fair market value, market value, fair value (accounting or legal), investment value, intrinsic value.
- The definition of value must fit the purpose; mismatches cause disputes.
2. Normalise a private company's earnings and cash flows for owner compensation, non-recurring items, related-party transactions and discretionary expenses, and distinguish strategic from financial buyers.
- Normalise to arm's-length, recurring, operating earnings.
- Add back excess owner pay; deduct pay below market; remove non-working family members.
- Restate related-party rent and purchases at market: above-market rent is added back, below-market rent deducted.
- Remove non-recurring items and personal expenses; value non-operating assets separately.
- Strategic buyers may include synergies (investment value); financial buyers value the stand-alone business.
3. Estimate a private company's required return with the CAPM, the expanded CAPM or the build-up method, and explain the judgements involved.
- CAPM uses a relevered beta from guideline public companies.
- Expanded CAPM: Rf + beta x ERP + size premium + company-specific premium.
- Build-up: Rf + ERP +/- industry premium + size premium + company-specific premium (beta assumed 1).
- Size premium data may embed illiquidity; avoid double-counting with a DLOM.
- Use the target's risk and a target capital structure; adjust optimistic forecasts directly.
4. Value a private company with income, market and asset-based approaches, including the capitalised cash flow, excess earnings and guideline company methods.
- CCM: V = FCFF1/(WACC - g) less debt; suits stable, mature companies.
- EEM: excess earnings = normalised earnings - returns on working capital and fixed assets; capitalise them to value intangibles.
- GPCM gives minority, marketable value; add a control premium for a controlling interest.
- GTM uses acquisition multiples that already include control (and possibly synergies).
- Asset-based approach suits holding, resource and liquidating companies; it is a floor for operating firms.
5. Calculate and apply discounts for lack of control and lack of marketability, and control premiums, in the correct order.
- DLOC = 1 - 1/(1 + control premium); a 25% premium implies a 20% discount.
- Income approach on normalised cash flows and transaction multiples give control values; public trading multiples give minority, marketable values.
- DLOM evidence: restricted stock, pre-IPO transactions, put option models.
- Apply the control adjustment first, then marketability; combine multiplicatively: 1 - (1 - DLOC)(1 - DLOM).
- Avoid double-counting illiquidity already in the discount rate or comparables.
Module at a glance
- Private companies differ in stage, size, management, information quality, liquidity and control; these shape every input.
- Valuations are transaction-, compliance- or litigation-related, and each purpose has its standard of value.
- Normalise owner pay, related-party terms, non-recurring and personal items; strategic buyers may add synergies.
- Expanded CAPM adds size and company-specific premiums to the CAPM; the build-up method uses ERP with an industry adjustment.
- CCM capitalises next year's FCFF; EEM values intangibles from excess earnings; GPCM gives minority values, GTM control values.
- DLOC = 1 - 1/(1 + control premium); total discount = 1 - (1 - DLOC)(1 - DLOM), control adjustment first.
This free module has 5 lessons, 16 practice questions with full explanations.