Private value

What Is Private Value?

Private value refers to the estimated worth of a company or asset that is not publicly traded on a stock exchange. Unlike market value, which is readily determined by real-time transactions in public markets, private value requires comprehensive valuation methodologies within the broader field of investment analysis. This value often reflects the potential for future cash flows, the underlying balance sheet assets, and the strategic importance to a specific buyer, rather than a price set by broad market consensus. Private companies, by their nature, do not offer securities to the general public and typically raise capital through private placements, often from sophisticated investors or institutions.²⁷, ²⁸

History and Origin

The concept of valuing non-public entities has existed as long as businesses themselves, evolving alongside capital markets. Before widespread public stock exchanges, all businesses inherently held "private value" determined through direct negotiation, often reflecting an individual's specific needs or the perceived future earnings capacity. The formalization of valuing private companies, however, gained significant traction with the rise of private equity and venture capital industries in the mid-20th century. These investment vehicles specialize in acquiring, investing in, and exiting private businesses, necessitating robust frameworks for assessing their worth.

The private markets, characterized by their limited liquidity and lighter regulatory oversight compared to public markets, have grown rapidly, attracting significant institutional investment over time.²⁵, ²⁶ The development of structured methodologies to determine private value became crucial as these markets expanded and became more sophisticated, moving beyond anecdotal assessments to more rigorous financial modeling. Early on, discussions around private equity recognized a "puzzle" in how these entities generated returns, emphasizing the need for comprehensive valuation strategies.²⁴

Key Takeaways

Illiquidity Impact: Private value is significantly influenced by the lack of a ready market for resale, often leading to a "discount for lack of marketability."
Methodology Dependent: Its determination relies heavily on various valuation models, such as Discounted Cash Flow (DCF), comparative analysis, and asset-based approaches.
Information Asymmetry: Less public disclosure requirements for private companies can lead to information asymmetry, impacting valuation.
Control Premium/Discount: The degree of ownership control being valued (e.g., controlling versus minority interest) directly affects the assessed private value.
Strategic Buyer Influence: The value can vary significantly based on whether the buyer is a financial investor or a strategic buyer who might realize synergistic benefits.

Formula and Calculation

While there isn't a single universal "private value" formula, the most common approach for valuing a going concern, whether public or private, is the Discounted Cash Flow (DCF) method. This approach calculates the present value of a company's projected future free cash flows.

The general formula for DCF is:

PV = \sum_{t=1}^{n} \frac{FCF_t}{(1+WACC)^t} + \frac{TV}{(1+WACC)^n}

Where:

(PV) = Present Value (the calculated private value or enterprise value)
(FCF_t) = Free Cash Flow for period (t)
(WACC) = Weighted Average Cost of Capital (the discount rate reflecting the company's capital structure and risk)
(n) = Number of periods in the explicit forecast
(TV) = Terminal Value (the value of the company beyond the explicit forecast period)

Another common adjustment in determining private value is the "discount for lack of marketability" (DLOM). This discount reflects the reduced value of an investment that cannot be easily or quickly converted into cash at a fair price due to the absence of an active trading market.²², ²³ There is no single formula for DLOM; instead, it is often derived from empirical studies or models, and applied as a percentage reduction to a preliminary valuation.²¹

For example, if a preliminary intrinsic value for a private company is determined, the private value for a specific illiquid stake would then be:

\text{Private Value} = \text{Preliminary Value} \times (1 - \text{DLOM})

Interpreting the Private Value

Interpreting private value requires a deep understanding of the underlying assumptions and the context of the valuation. Unlike a publicly traded stock where the market provides immediate feedback, the private value is an estimated figure based on a range of inputs and projections. A high private value might indicate strong future growth prospects, a solid income statement, or unique competitive advantages. Conversely, a low private value could signal high risks, limited growth opportunities, or a distressed financial situation.

The interpretation also depends on the purpose of the valuation. For a shareholder looking to sell their stake, the private value represents the potential sale price. For a private equity firm considering an acquisition, it helps determine the appropriate bid. Factors such as the company's stage of development, industry, geographic location, and specific characteristics of its capital structure all play a critical role in how the derived private value should be understood and applied.

Hypothetical Example

Imagine "GreenTech Innovations," a privately held startup developing advanced renewable energy solutions. The company is seeking a new round of funding. An investor is considering purchasing a minority stake.

Step 1: Financial Projections
The investor's analysts project GreenTech's free cash flows for the next five years and estimate a terminal value beyond that period.

Year 1 FCF: $1 million
Year 2 FCF: $1.5 million
Year 3 FCF: $2 million
Year 4 FCF: $2.5 million
Year 5 FCF: $3 million
Terminal Value (Year 5): $40 million

Step 2: Determine Discount Rate
Based on GreenTech's risk profile and capital structure, the Weighted Average Cost of Capital (WACC) is determined to be 15%.

Step 3: Calculate Preliminary Value (DCF)

PV = \frac{\$1}{(1+0.15)^1} + \frac{\$1.5}{(1+0.15)^2} + \frac{\$2}{(1+0.15)^3} + \frac{\$2.5}{(1+0.15)^4} + \frac{\$3}{(1+0.15)^5} + \frac{\$40}{(1+0.15)^5}

Calculating this, the preliminary enterprise value might be approximately $35 million.

Step 4: Apply Discount for Lack of Marketability (DLOM)
Since GreenTech is a private company, the investor recognizes the lack of liquidity. Based on comparable private transactions and market conditions, a 25% discount for lack of marketability is deemed appropriate.

Step 5: Calculate Final Private Value

\text{Private Value} = \$35 \text{ million} \times (1 - 0.25) = \$26.25 \text{ million}

Therefore, the estimated private value of GreenTech Innovations, after accounting for its illiquidity, is $26.25 million. This forms the basis for negotiations regarding the investor's stake purchase.

Practical Applications

Private value is a critical concept in numerous financial contexts where market prices are unavailable. It is fundamental in:

Mergers and Acquisitions (M&A): Buyers and sellers of private companies rely on private valuation to determine fair transaction prices. For instance, when private equity firms acquire companies, they conduct extensive due diligence and valuation to determine an appropriate purchase price.²⁰
Venture Capital Funding Rounds: Startups raising capital from venture capitalists or angel investors receive valuations that establish the price per share for new investment. These valuations directly influence the equity stake new investors acquire and the dilution of existing shareholders.
Estate and Gift Taxation: For privately held businesses, estates and gifts involving ownership interests require a formal valuation to assess tax liabilities.
Employee Stock Option Plans (ESOPs): Private companies often grant stock options to employees. The exercise price of these options is based on the company's private value, which must be regularly assessed.
Litigation and Dispute Resolution: In legal disputes, such as divorce proceedings or shareholder disagreements, an independent private valuation is often necessary to divide assets fairly.
Strategic Planning: Management of private companies uses private value assessments to understand their wealth creation, track performance, and inform strategic decisions, including potential future initial public offerings (IPOs) or sales. The market's enthusiasm, for example, for AI has been observed to lift valuations for both public and private holdings.
Portfolio Management: Institutional investors with allocations to private assets, such as pension funds and endowments, periodically value their holdings to assess return on investment and manage portfolio risk.

Limitations and Criticisms

Despite its necessity, determining private value comes with inherent limitations and faces several criticisms:

Subjectivity and Assumptions: Valuation models, particularly Discounted Cash Flow (DCF), rely heavily on subjective future projections and assumptions about growth rates, discount rates, and terminal values. Small changes in these assumptions can lead to significant swings in the estimated private value.
Lack of Liquidity: As discussed, the illiquid nature of private assets means there's no continuous market feedback to validate the valuation. The "discount for lack of marketability" applied is itself an estimate, which can vary widely.¹⁸, ¹⁹ This opacity in private markets can make true valuations challenging.¹⁶, ¹⁷
Information Asymmetry: Private companies are not subject to the same rigorous disclosure requirements as public companies. This can lead to a lack of comprehensive and timely financial data, making it difficult for external parties to conduct thorough investment analysis.
Infrequency of Transactions: Private companies are bought and sold far less frequently than publicly traded stocks, limiting the availability of comparable transaction data. When transactions do occur, they may be highly specific to the parties involved, making direct comparisons challenging.
Bias: Valuations can be influenced by the interests of the party commissioning them. For instance, a seller might seek a higher valuation, while a buyer might aim for a lower one. Independent appraisers strive for objectivity but may still face challenges in obtaining unbiased information.
Difficulty in Adjusting for Risk: Accurately quantifying the specific risks inherent in a private company (e.g., key person risk, concentration risk, lack of diversification) and reflecting them in the discount rate or through specific discounts can be complex.

Private Value vs. Intrinsic Value

While closely related, private value and intrinsic value are distinct concepts in valuation.

Feature	Private Value	Intrinsic Value
Definition	The estimated worth of a non-publicly traded company or asset, considering its specific characteristics and the absence of a liquid market.	The true, inherent worth of an asset or company, based on its underlying fundamentals, independent of its market price.
Marketability	Explicitly accounts for lack of liquidity (e.g., via a Discount for Lack of Marketability).	Does not inherently include a discount for lack of marketability; assumes the asset could be freely traded if valued at its fundamental worth.
Application	Primarily used for private companies, M&A, private equity, venture capital.	Applied to both public and private entities to determine their fundamental worth, often compared against market value for investment decisions.
Perspective	Often takes into account specific buyer/seller circumstances or strategic benefits.	A more theoretical concept, representing the "correct" value if all information were known and fully rational.

In essence, private value is often the intrinsic value of a private entity, adjusted for its unique characteristics as a non-public asset, primarily its illiquidity. An asset's intrinsic value might be calculated using a Discounted Cash Flow (DCF) model, and then a private value would be derived by applying a discount to that intrinsic value to reflect its limited tradability.

FAQs

What factors make private value different from a public company's valuation?

The primary distinguishing factors are the lack of liquidity, limited public disclosure, and the absence of an active trading market for private companies. These elements necessitate different valuation approaches and often result in a discount compared to a similar public company.¹⁵

Is private value always lower than what a company would be worth if it were public?

Not necessarily. While the lack of liquidity often leads to a "discount for lack of marketability," a private company might have strategic value to a specific acquirer that would not be fully reflected in public markets. Additionally, private companies can avoid the costs and regulatory burdens associated with being public, which can also impact their underlying intrinsic value.

How do investors typically determine the private value of a startup?

Investors, particularly in venture capital, use various methods including Discounted Cash Flow (DCF) for more mature startups, but also consider approaches like the venture capital method, comparable company analysis (using private or public comparables), and asset-based valuations for early-stage companies. The private value assessment heavily weighs future growth potential and the associated risks.

Can private value change rapidly?

Yes, private value can change rapidly, especially for growth-stage companies. Significant events like new funding rounds, major product launches, shifts in market conditions, or changes in key personnel can quickly alter perceptions of a company's future prospects and, consequently, its estimated private value.¹ ², ³ ⁴, ⁵ ⁶ ⁷ ⁸, ⁹[¹⁰](https://edu.nacva.com/preread/2012BVTC/2012v[¹³](https://www.sec.gov/resources-small-businesses/exempt-offerings/private-placements-rule-506b), ¹⁴1_FTT_Chapter_Seven.pdf)¹¹, ¹²