How Market Forces Impact Private Company Valuations

April 6, 2016

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In general, stock markets reflect public company trading activities and share prices, and most owners of privately held companies would not normally consider the market ups and downs when valuing their business. This is not unusual given that private companies are not affected by the myriad factors that influence public company stock prices, such as market mentality, analyst coverage and ratings, future expected earnings and profits, etc. However, there are still a few market forces that can impact the valuation of a private company, some of which include:

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  • Discount Rates – assuming it was determined that the best method to value a particular company is using the income approach, the valuator needs to select a discount rate that reflects both the time value of money and the particular risks in expected or future cash flows. Although deriving a discount rate is beyond the scope of this blog, generally market rates of interest, such as the risk-free rate (i.e., return available on government bonds), prime and inflation, are considered and/or used when computing an appropriate discount rate. As such, market forces do impact rates of interest and will ultimately affect the discount rate(s) that will be used in the valuation of a private company.
  • Company multiples – sometimes it is appropriate to use public company multiples or data to derive a value for a private company. Such instances include when a public company is comparable to the private company in question. This is considered when companies operate in the same (or similar) industry, have similar customers and competitors, etc. Valuators will normally consider common valuation multiples (e.g., EV/Revenue, EV/EBITDA, etc.)[1] of similar companies if they are readily available, and then adjust these similar company multiples to reflect the private company’s own risk profiles. As such, when market forces drive public company multiples up or down, using the market approach to value a private company will be ultimately impacted by market forces.

Although market forces are seemingly isolated from privately-held companies, changes in the marketplace can directly impact the valuation of a private company given the interrelationships and common factors seen in both public company and private company business operations.

[1] EV stands for Enterprise Value, which is defined as the total value of all the operating assets of the business, including net working capital, fixed assets and intangible assets.

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