Private Discount Premium - Why Non Public Companies are Negotiated at Lower Relative Prices

Breno Pavao

Master's thesis

Private Firm Valuation & The Liquidity Premium

Abstract:

The current study proposes a model based on CAPM and valuation multipliers to capture the risk for privately held companies with the information normally available for it. The main assumption is that the relative price differential between the average private and public company reflects all additional risk brought by the private market, this difference is then annualized through dividend discount model to be in the same terms as other CAPM’s variables. Then a possible justification for this premium is done through liquidity differentials, the premise is that liquidity is driven mainly by number of market participants which makes the market more efficient and the supply and demand dynamics balanced, creating an environment where assets are traded closer to their intrinsic value. Private markets by their own nature are riskier and present higher degree of information asymmetry, this would drive away investors not willing to be exposed to such risk and would decrease the market liquidity and overall asset prices with it. To test for this hypothesis, a correlation analysis of market participant’s proxy indicators and the observed premium is done.

Abstract:

The current study proposes a model based on CAPM and valuation multipliers to capture the risk for privately held companies with the information normally available for it. The main assumption is that the relative price differential between the average private and public company reflects all additional risk brought by the private market, this difference is then annualized through dividend discount model to be in the same terms as other CAPM’s variables. Then a possible justification for this premium is done through liquidity differentials, the premise is that liquidity is driven mainly by number of market participants which makes the market more efficient and the supply and demand dynamics balanced, creating an environment where assets are traded closer to their intrinsic value. Private markets by their own nature are riskier and present higher degree of information asymmetry, this would drive away investors not willing to be exposed to such risk and would decrease the market liquidity and overall asset prices with it. To test for this hypothesis, a correlation analysis of market participant’s proxy indicators and the observed premium is done.

Keywords

Valuation, Valuation Multiplier, Relative Valuation, Total Beta, Private Company Valuation, Equity Risk Premium, CAPM, Company-Specific Risk, Liquidity Premium, Discount for Lack of Marketability

Keywords

Private Company Valuation, Equity Risk Premium, CAPM, Total Beta, Liquidity Premium, Discount for Lack of Marketability, Valuation, Valuation Multiplier, Relative Valuation, Company-specific Risk, Modified CAPM

Language used: English

Date on which the thesis was submitted / produced: 6. 11. 2019

Thesis defence

• Date of defence: 10. 6. 2020
• Supervisor: František Poborský
• Reader: Petr Horák

Vysoká škola ekonomická v Praze

Master programme:
Finance and Accounting