Alternative investments closely held company valuation query

deepakkrkanodia
Finance Junkie
Posts: 49
Joined: Thu Aug 09, 2012 4:45 pm

Alternative investments closely held company valuation query

Postby deepakkrkanodia » Mon Oct 08, 2012 1:06 pm

plz explain in simple terms what do we mean by this paragraph along with real examples.

When valuing closely held companies, lack of liquidity and lack of marketability can both be important factors.value can be determined by analyzing operationally similarly public traded companies to establish a base value, to which the liquidity and marketability discounts can be applied. Another factor to be considered is whether the block of shares being valued represents a controlling interest in the company. A DISCOUNT for minority interest may be necessary for valuing a position that lacks the ability to influence corporate decision making if the benchmark value is for controlling interest in a private company. Likewise ,a PREMIUM would be appropriate for the valuation of a controlling ownership position if the benchmark value is for publicly traded shares, which represents a minority interest.

plz explain this para in simple layman terms and also base value as well as control DISCOUNT and control PREMIUM emphasis with examples.

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pankaj
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Posts: 61
Joined: Fri Aug 03, 2012 11:24 am

Re: Alternative investments closely held company valuation q

Postby pankaj » Tue Oct 09, 2012 7:26 pm

Lack of Liquidity – Because closely held co.’s securities are illiquid, some discount must be made for the illiquidity to compensate investors for illiquidity in the market for shares.

Lack of Marketability: There is no public market for shares of closely held co.’s (i.e. share are not traded in the public market or organized market like NSE or BSE, so the share price is not set by the interaction of demand and supply in the market), therefore their valuation should reflect a marketability discount to compensate for extra return investors may require.

Discount for Minority Interest: The minority discount is applied if the minority shareholders (representing minority interest) are not able to influence company’s decision or corporate strategies.

For example: you are planning to buy 10% equity of ABC company and you know, you will not be able to influence the corporate decisions in ABC – in this case you will be called as minority shareholder. Therefore, when you will do valuation (i.e. at what price you should buy the 10% equity), you will apply extra discount to the discount rate used in the valuation to compensate yourself for not getting the power/rights to influence company decisions which other controlling shareholders can do.

Control Premium: Suppose you are buying a controlling stake in a closely held company and to value the subject company you used a comparable publicly traded shares that represents a minority interest. Now in this case to value the controlling position, you need to apply a premium to the valuation (it is like you are getting extra power/option for which you need to pay extra - nothing is free in this world!!!).

In the above case you are valuing the company from a control perspective, now suppose, you are still in the controlling position but want to value the minority position in the company. In this case, in addition to the market price of publicly traded share (if you used a publicly traded shares as comparable), the valuation of minority interest in a closely held company may require discount for liquidity, discount for marketability and a premium for control (this is like you are giving extra money to minority shareholder to retain your controlling position).

Hope this help!

deepakkrkanodia
Finance Junkie
Posts: 49
Joined: Thu Aug 09, 2012 4:45 pm

Re: Alternative investments closely held company valuation q

Postby deepakkrkanodia » Wed Oct 10, 2012 12:52 pm

mr pankaj

thx for explaining

regards

deepak


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