What is the difference between public and private company valuation models?

Irrespective of whether a company is private or public, valuation is a function of supply and demand. The benchmark numbers are usual financial / operational metrics (depending on what is available) and then the market decides if they should trade at a higher multiple or lower multiple, depending on sentiments around that industry / company / management. The reason private market multiples are more volatile is because the market is less efficient there (lower number of buyers and sellers). The volatility decreases in public markets and there is a spectrum there too - depending on the market cap of the company.

Public company valuation models are methods used to assess the worth of publicly traded firms. Key approaches include market-based models like Price-to-Earnings (P/E), Price-to-Sales (P/S), and Price-to-Book (P/B) ratios, which compare stock prices to various financial metrics. Income-based models, such as the Discounted Cash Flow (DCF) method, project future cash flows and discount them to present value. Asset-based models like Net Asset Value (NAV) determine a company’s value by calculating net assets. Comparable Company Analysis (CCA) compares financial metrics to peers. These models inform investment decisions, strategic planning, and stock analysis, but their accuracy depends on data quality and market conditions.

In public company valuations, the influence of market liquidity is paramount. Shares of public companies are bought and sold frequently, providing a continuous indication of what the market believes a company is worth. This liquidity means values can change rapidly in response to market news, making it vital for investors to stay abreast of global events and industry trends that could affect stock prices. A public company's valuation is thus a reflection not just of its financials but also of the broader market's sentiments and speculations.

Market sentiment can significantly affect a public company's share price. For CXOs, understanding that your company's public perception can affect your market-based valuation is crucial.

Understanding Valuation Models for Public and Private Companies - Public companies trade on stock exchanges, making market-based valuation models relevant. - Public company valuation often relies on metrics like Price-to-Earnings (P/E) ratios. - Market data is readily available and helps assess a public company's value. - Private companies lack public data, making valuation more challenging. - Private company valuations may use methods like discounted cash flows. - Professionals should be well-versed in both public and private company models. - Valuation knowledge is crucial for investors, business owners, and financial experts.

In the private companies world, it is usually a combination of comparable companies multiples / precedent transactions with a potential DCF check. DCF are highly sensitive to very debatable assumptions - WACC as well as long term growth - and this often results in too judgmental valuations. Hence why either public comparables or precedent transactions comps are the most relevant. Make sure you build the most relevant sample - in terms of sector but also size, float, type of transactions, majority / minority, margins, growth rate - and be quite rigorous when determining the premium / discount to apply to the median or average multiples.

The valuation of private companies must often factor in the potential interest of strategic buyers, which can dramatically affect the perceived value. A strategic buyer may value a private company well above traditional valuation methods if it believes the acquisition will provide synergistic benefits, such as access to new markets or technologies. This consideration is unique to private valuations and requires a nuanced understanding of both the buyer's and the company's long-term strategic goals.

The discounted Cash Flow valuation method is one of the most used valuation methods for private co. Getting the net present value of the next 5 years cash flow ( levered and unlevered cash flow) added by the terminal value would help to get the intrinsic and enterprise value including the factor IRR, Cost of capital etc..

For CXOs, it's important to understand that the lack of liquidity in private shares can also affect valuation. Often, a liquidity discount is applied, which can range from 20% to 30%, to account for this.

When performing valuation for reporting or academic purposes, the tried and true DCF and comparable models are great. However, in the "real world" of valuation, during an acquisition with an actual buyer involved, the true king of metrics is the clean multiple of EBITDA, for profitable companies at least. Buyers will have a host of perspectives on what multiple to choose, lending from their available cap structure, economies of scale, internal forecasts of the market, and how the target business fits into the overall long term picture of the buyer's plans. Capturing the right components of a normalized TTM EBITDA is a crucial exercise in this model, including non business items, one time items, and month to month smoothing.

When Dell went from being a public to a private company in 2013, the valuation became complex and relied more on projections. This shift impacted investor confidence, led to intricate negotiations with Michael Dell and Silver Lake Partners, and influenced the terms of the deal. It also had implications for taxation and compliance. Finally, the private valuation allowed them to focus on long-term growth strategies without public shareholder pressures. For CXOs, understanding that public and private valuations also dictate the types of investors you can attract is crucial. Private companies might have more flexibility but could face challenges in attracting institutional investors who rely heavily on public financial disclosures.

Significance of Public vs. Private Valuation Models - Accuracy and reliability of valuation results are impacted. - Confidence levels of investors and stakeholders vary accordingly. - Influences decision-making and negotiation processes. - Terms and conditions of deals are shaped by these differences. - Taxation, regulation, and compliance aspects are affected. - Reflects the company's risks, opportunities, and growth potential.

The importance is vast understanding the difference between public and private company valuation models is essential because it impacts the methods used, the availability of data, and the nuances of risk assessment, ultimately influencing the accuracy of valuations and their implications for various financial decisions.

One thing I have found is the difference matters for a few key reasons: 1. The risk profile of private versus public valuation can easily be illustrated by showing the business owner the discounts or risk factors correlated to their business model. 2. The valuation of a company is not the selling price of the company. An appraisal or valuation provides insights based on known information, but buyers and sellers are still free to negotiate based on external factors not included in the valuation model. 3. The levels of company and market valuation are different based on how the buyer can capitalize or generate a return on the assets.

The most important purpose of the valuation model is to put a price on the company. The entire exercise is basically to create a price tag for the company under evaluation. The difference between the 2 valuation models is important for various reasons - One, being the investability and expected longevity of public companies are much higher than private companies. Two, the public companies already have a price which is quoted on the stock exchanges which can act as an anchor for any advisor creating its valuation model and match it to the trading price for evaluation. Private companies do not have such publicly available prices. This makes their valuation subject to many subjective assumptions and even biases.

You select the model that will enable you to provide the user of the report, the greatest confidence for its purpose. For example, the market approach would be most applicable for the sale of a business (for the seller). The income approach would be most applicable for the buyer buying that business due to the projections, risk, and earnings expectations.

For CXOs, it's crucial to understand that the choice of model can greatly influence investment decisions. For instance, a DCF model might show strong long-term potential, attracting long-term investors, while market-based models might appeal to short-term traders. Sometimes neither model is wholly sufficient, especially for companies that are hybrid in nature (partly public through IPO but with significant private equity backing).

Selecting the Appropriate Valuation Model - No universal model for valuing companies, public or private. - Choice depends on valuation purpose, context, data quality, and more. - Public companies often benefit from market-based models. - They capture current market conditions and investor sentiment. - Private companies find discounted cash flow models more fitting. - DCF reflects intrinsic value and long-term cash generation. - Always employ multiple models and cross-check results for a balanced valuation.

In my industry experience, choosing the right valuation model and asset pricing advisory can make or break the success of a transaction. Private to private sale often experiences no additional synergies or little opportunity to augment the earning potential of the business. Whereas private equity or public entities that acquire private companies often acquire with non-cash flow values considered. This is because they are able to arbitrage differences in capitalization between private lack of liquidity to fully capitalized or liquidity premiums in their marketability.

It is important what share of the company is valued and for what purposes. Whether it is a public company or a private company is not at all important for the purposes of choosing the type of model. With one exception, the assessment of the liquid share of a public company. In this exception, the stock quote is simply taken for calculations. In all other cases, the valuation model is chosen regardless of whether the company is public or private. The differences are manifested in the assessment of risk based on liquidity, transparency etc. For the DCF model, the risk will be taken into account in the discount rate. It is interesting to note for a long-term portfolio investor in mature companies, there is only the DCF valuation model.

For CXOs, a strong foundational knowledge in valuation can dramatically improve decision-making. For instance, a CEO with a firm grasp on valuation techniques can more effectively negotiate mergers or acquisitions. By the same logic, CFOs can better manage corporate finances and risk.

Enhancing Your Valuation Skills - To enhance financial modeling and valuation skills, practice is key. - Seek online courses, books, blogs, podcasts, and videos for theory and examples. - Utilize available templates and tools to refine your skills. - Engage with online communities, forums, and groups to discuss and share insights. - Don't hesitate to ask for feedback and advice from experts. - Participate in valuation competitions and challenges to showcase your skills.

There are a lot of materials available online for this. But what I have experienced is that Practice is the key. The more model you create, the better you become.

Most important is to have a glance overview on valuations, and start valuations with different models and methods. Refine the templates and minimize manual interventions. Involvement in relative community and forums, relatives blogs, and real case studies ( e.g. Valuation Report Q Free ASA Deloitte).

A key skill of someone who performs valuations should be understanding the buyer or seller's motivations and goals for the valuation. Financial modeling is important, but developing other professional skills are equally as important to understand purpose, valuation goals, and recognizing other factors to include in a valuation model.

One thing I've found helpful is joining industry associations for valuation professionals. While financial modeling and modeling theory can be discussed, each industry can have nuanced applications that should be considered. Networking with others who are experienced in valuation application and industry experience can help you develop your expertise and potentially learn standards and best practices for your industry.

To stay updated on the differences between public and private company valuation models, I rely on various sources. I regularly review finance and economics literature, follow industry-specific news outlets, and monitor financial blogs and websites for insights from experts. Additionally, I keep an eye on changes in regulations and standards related to financial reporting and valuation practices. Engaging with professionals in the field, attending webinars, and participating in online forums and communities also help me stay current on evolving trends and best practices in both public and private company valuation.

Everyone reading this article is supposedly aware of the 7 steps of building a DCF model for Public listed companies. Here are 3 adjustments we need to make to value Private Companies.. 1. Finanicals: Adjust financials to remove owner/Founders related expenses. Financials are typically unaudited. 2. Cost of debt: Use leverage ratio of the private company and compare to public listed companies to gauge the spread over risk free rate to calculate cost of debt. 3. Cost of Equity: Calculate Beta by 1. Unlevering the beta of public competitors. Adjust it for R square to capture firm specific risk (As acquirer cannot diversify risk by buying other companies as a fund manager can when constructing portfolio of shares)

Public vs. Private Company Valuation: A quick Snapshot Public Companies: Market Cap: Stock price x outstanding shares. Comparables: Use metrics (e.g., P/E ratios) of similar public firms. Data Abundance: Mandated regular disclosures ensure transparency. Liquidity Boost: Readily tradable shares can elevate value. Private Companies: Discounted Cash Flow: Project future cash, discount to present value. Precedent Transactions: Value based on similar past deals. Data Scarcity: Limited disclosures mean relying on estimates. Illiquidity Discount: Hard-to-trade shares might reduce value. Why It Matters: Public valuations are sentiment-driven, while private ones hinge on intrinsic factors.

Public valuation is usually a pricing game (market multiples comparables) while in private valuation you to to get the intrinsic value (future financial performance/ investment on the company and capital structure)

One should keep in mind the industry in which the company operates while deciding the valuation techniques. for example, the valuation of a financial institution will be different from an online business. The former is dependent on cheap sources of funds and quality of underwriting whereas the second one is dependent on lowering customer acquisition costs and cash burns. It's important to understand the metric that captures the underlying of the business. One must not forget that investors tend to be irrational. A killer acquisition or a strategic acquisition can take place at a price higher than derived by any technique. Initially, in 2008 the price of asset-backed securities kept on rising when the underlying mortgages started defaulting