Two Q from the new Private Company Valuation section

Assume a minority shareholder holds 10% of a private firm’s equity, with the CEO holding the other 90%. Using normalized earnings, the value of the firm’s equity is estimated at $20 million. The CEO refuses to sell the firm and the minority shareholder cannot sell their interest easily. A discount for lack of marketability (DLOM) of 15% will be applied. A discount for lack of control (DLOC) will also be estimated. Using reported earnings instead of normalized earnings provides an estimated firm equity value of $19 million. Which of the following is closest to the value of the minority shareholder’s equity interest? A) $1,700,000. B) $1,615,000. C) $1,900,000. Your answer: C was incorrect. The correct answer was B) $1,615,000. Given these figures, the value of the minority shareholder’s equity interest is: Firm’s equity value $19,000,000 Minority interest 10% Value of minority interest without discounts $1,900,000 minus DLOC of 0% 0 Value of interest if marketable $1,900,000 minus DLOM of 15% $285,000 Value of minority interest $1,615,000 ---------------------------------------- Question: Why is equity based on reported vs. normalized earnings used (i.e. 19M vs. 20M)? The reading constantly implies that we should normalize earnings, such as when doing EBITDA ratios. An analyst is valuing a private firm on the behalf of a strategic buyer and deflates the average public company multiple by 15% to account for the higher risk of the private firm. Given the following figures, calculate the value of firm equity using the guideline public company method (GPCM). Market value of debt $4,100,000 Normalized EBITDA $42,800,000 Average MVIC/EBITDA multiple 8.5 Control premium from past transaction 25% The value of the firm’s equity is closest to: A) $382,438,000. B) $304,060,000. C) $385,200,000. The correct answer was A. The adjustment to the MVIC/EBITDA multiple for the higher risk of the private firm is: 8.5 × (1 - 0.15) = 7.225. Given that the buyer is a strategic buyer, a control premium adjustment should be made: 7.225 × (1 + 0.25) = 9.031. The adjusted multiple is applied against the normalized EBITDA: 9.031 × $42,800,000 = $386,537,500. Subtracting out the debt results in the equity value: $386,537,500 - $4,100,000 = $382,437,500. ---- Question: The answer says “Given that the buyer is a strategic buyer, a control premium adjustment should be made.” Is it true that CP is not made for a financial buyer (one not looking for synergies)? I don’t recall the text around control premiums making this distinction.

not sure about the second one, but when I answered the first, I used the 19mm b/c this is the unadjusted value. Unadjusted value must be used in this case as we are valuing a non-controlling interest, which means we are valuing from the perspective of an investor who doesn’t have the control to “normalize” earnings. In short, the DLOC is built into the equity value.

ahhh i remember…in this chapter “normalized earnings” are defined as firm earnings if the firm were acquired/controled…so since they allude to only 10% control and also say “discount for lack of control (DLOC) will also be estimated”, this gives it away that earnings cannot/will not be normalized. thanks for your help on this. would appreciate any other insight on the second Q.

I was under the impression that the control premium would be added regardless of whether it is a financial or strategic buyer, as regardless of synergies, they are still purchasing control. The distinction between financial and strategic is included in the 15% deflated multiple. If I am incorrect, I would appreciate someone setting me straight on this.

i am bumping this up, because Fargo (am practice) #41’s solution says that mvic/ebitda includes the cnntrol premium while the second example given above says otherwise.

can anyone clarify? thanks.

They used multiples from transactions, not public companies.

The sale price of transactions include a premium for control, while multiples for normal running company’s do not.