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CFA Level II · CFA Level II Exam

Private Company Valuation for CFA Level II

Private company valuation estimates the value of a firm with no active public market for its shares. You pick a purpose, normalize the financials, then apply income, market or asset-based approaches. Next you adjust for discounts and premiums, match the level of value, and reconcile the results into one conclusion.

What this chapter covers

This chapter covers how to value a business or equity interest that does not trade on an exchange. It starts with why the valuation is being done, because the purpose sets the standard of value and the method. It then walks through the three approaches: income, market and asset-based. Finally it deals with the adjustments that move you from one level of value to another.

The tools are not new. You use FCFF, FCFE, discount rates, capitalization rates and multiples that you learned in Equity Valuation and Corporate Finance. What changes is the data. Private firms have thin or unreliable financials, no market price, and owners who may take unusual pay or perks. So much of the work is judgment: normalizing earnings, building a discount rate without an observable beta, and choosing comparables.

The chapter connects to Financial Statement Analysis through earnings quality and normalization. It connects to Corporate Finance through cost of capital and control issues. It also connects to Equities through free cash flow models and multiples. On exam day it appears inside an item set, so you must pull the right numbers from a vignette and apply the right adjustment in the right order.

Private company valuation draws on equity valuation concepts and carries weight within the exam's valuation topics, and it rewards candidates who are methodical. Questions are often short calculations plus a conceptual choice, such as which discount applies or which level of value you are at. Once you learn the order of adjustments, these marks are very reachable. The same ideas also help with other items that mix valuation with control, liquidity and cost of capital.

Private Company Valuation: topics in the order to study them

  1. 1Private Company Valuation Scope and PurposesStart here because purpose drives the standard of value, the method and the adjustments you apply later.
  2. 2Private vs Public Company Valuation IssuesThis explains why private valuation is harder, and it sets up normalization and the extra risks in the discount rate.
  3. 3Income Approach: FCFF, FCFE and Capitalized Cash FlowIt reuses cash flow models you already know, so it is the best base for the numerical work.
  4. 4Market Approach: Guideline Public and Transaction MethodsOnce you can value by cash flow, you can compare it with multiples from similar public firms and deals.
  5. 5Asset-Based ApproachIt is shorter and simpler, and it makes most sense after you know when income and market methods are weak.
  6. 6Valuation Discounts and PremiumsApply these only after you have a base value, so learn them after the three approaches.
  7. 7Valuation Level of Value and ReconciliationThis ties everything together by showing which level your value sits at and how to weigh several results.

How to prepare Private Company Valuation

Treat this chapter as a sequence of decisions. Learn the order, then practise reading vignettes for the data that triggers each decision.

  1. Read the scope and purposes material first and write down how purpose changes the standard of value and the method you would pick.
  2. List the reasons private valuation differs from public valuation, and link each reason to a specific fix, such as normalizing earnings or adding a size or company-specific premium.
  3. Rework the income approach by hand: FCFF with WACC, FCFE with cost of equity, and capitalized cash flow. Check that the cash flow, the discount rate and the growth rate all match each other.
  4. Practise the market approach with multiples from guideline public companies and from transactions. Note which adjustments each one needs, including differences in size, growth and control.
  5. Build a one-page ladder of discounts and premiums and the levels of value. Practise moving a value up or down the ladder in the correct order.
  6. Finish with item sets that mix methods. For each, say aloud which approach fits, which adjustments apply, and how you would weigh the results.
  7. In the final days, redo only the questions you got wrong and recite the key definitions and conditions.

Common mistakes in Private Company Valuation

  • Applying a discount or premium that is already built into the base value.

    Fix: First state the level of value of your base figure. Then adjust only for the difference to the target level.

  • Using the wrong discount rate for the cash flow, such as WACC on FCFE.

    Fix: Pair FCFF with WACC and enterprise value, and FCFE with cost of equity and equity value. Subtract debt only when you move from enterprise value to equity value.

  • Skipping normalization of earnings.

    Fix: Scan exhibits for above-market salaries, personal expenses and non-recurring items, and adjust before applying any multiple or model.

  • Mixing up DLOC and the control premium.

    Fix: Remember DLOC = 1 − 1 ÷ (1 + control premium), and check the direction of the move before calculating.

  • Adding DLOC and DLOM together when both apply.

    Fix: Combine them multiplicatively: total discount = 1 − (1 − DLOC)(1 − DLOM). Apply them in sequence to the value, each to the result of the previous step.

  • Averaging all value estimates equally during reconciliation.

    Fix: Weight each method by data quality and fit with the purpose, and say why a method gets more weight.

  • Choosing a method without reading the purpose.

    Fix: Read the stated purpose and the company type first, then pick the approach that fits.

Last-day revision: Private Company Valuation

  • The purpose of the valuation sets the standard of value, the method and the adjustments.
  • Private firms need normalized earnings: remove unusual owner pay, perks and one-off items before valuing.
  • Income approach: use FCFF with WACC, or FCFE with cost of equity, and keep cash flow and rate consistent.
  • Capitalized cash flow applies a growing perpetuity: value = next-period cash flow ÷ (r − g), i.e. cash flow ÷ capitalization rate.
  • Market approach: guideline public company method uses multiples from similar traded firms, and the transaction method uses multiples from actual deals.
  • Multiples from public firms reflect a marketable, minority value, so check what the multiple implies.
  • The standard framework has four combinations of levels of value: controlling or non-controlling, each either marketable or non-marketable. The commonly used three-level chain, from highest to lowest, is controlling marketable > non-controlling marketable > non-controlling non-marketable.
  • Moving down between levels: from controlling marketable to non-controlling marketable, apply a discount for lack of control (DLOC). From non-controlling marketable to non-controlling non-marketable, apply a discount for lack of marketability (DLOM). Moving up reverses each step: remove the DLOM by dividing by (1 − DLOM), then apply a control premium by multiplying by (1 + control premium).
  • Asset-based approach suits asset-heavy or break-up cases, using fair values of assets less liabilities.
  • A discount for lack of marketability (DLOM) reduces value for poor liquidity.
  • A control premium raises value to reflect control, and a discount for lack of control (DLOC) reverses it.
  • The relation between DLOC and the control premium is DLOC = 1 − 1 ÷ (1 + control premium).
  • Apply adjustments in order: start from the level of value your base method produces, then move one level at a time toward the target level. Going down, apply DLOC first, then DLOM. Going up, remove DLOM first (divide by 1 − DLOM), then apply the control premium (multiply by 1 + control premium).
  • Combine discounts multiplicatively, not by adding: total discount = 1 − (1 − DLOC)(1 − DLOM). For example, a 20% DLOC and a 10% DLOM give 1 − 0.80 × 0.90 = 28%, not 30%.
  • Reconcile several value estimates by weighing them by reliability and data quality, not by a simple average.

Private Company Valuation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Private Company Valuation: frequently asked questions

How is private company valuation different from public company valuation?

Private firms have no market price, less reliable financials and limited liquidity. You normalize earnings, build a discount rate without an observed beta, and often adjust for lack of marketability and control.

What is the difference between DLOM and DLOC?

A discount for lack of marketability reflects that shares cannot be sold quickly at a known price. A discount for lack of control reflects that a minority holder cannot direct the firm. They answer different problems and may both apply. When both apply, combine them multiplicatively, not by adding.

How do I know which approach to use?

Start with the purpose and the nature of the business. Income methods suit going concerns with forecastable cash flows, market methods suit firms with good comparables, and asset-based methods suit asset-heavy or break-up cases.

Will this chapter appear as a calculation or as theory?

Both are possible, and they come inside an item set with a vignette. Expect to pull data from exhibits, apply a model or adjustment, and sometimes choose between conceptual statements.