CFA Level II Exam · Private Company Valuation

Private vs Public Company Valuation Issues in CFA Level II

Updated 7 October 2026 · Fact-checked

Private company valuation is harder than public valuation because information is limited, shares are illiquid, control is often concentrated, and reported earnings are distorted by owner choices. You solve it by normalising earnings and cash flows, adjusting discount rates for extra risk, then applying marketability and control adjustments at the right level of value.

Understand Private vs Public Company Valuation Issues

A public company has a quoted price, audited filings and many analysts. A private company has none of these. The valuer must build the value from scratch, using whatever data management provides.

The main differences are:
- Limited information. Financial statements may be unaudited, may follow no standard, and forecasts may be thin. Management may be the only source.
- Lack of marketability. There is no ready market to sell the shares. A buyer wants compensation for this, so value falls, usually through a discount for lack of marketability (DLOM).
- Concentrated control. One owner or family may decide dividends, pay, strategy and any sale. This changes the value of a minority stake compared with a controlling stake.
- Key person risk. Value may depend on a founder's skills or relationships. If that person leaves, cash flows may fall. This is often handled in the cash flows or the discount rate.
- Discretionary and non-market items. Owners may pay themselves above or below market salary, or run personal costs through the company. These distort earnings.

Because of this, you normalise earnings before valuing. Normalisation removes non-recurring items (one-off gains, losses, lawsuits) and adjusts owner-related items to market levels (owner pay, related-party rent, personal expenses). It also aligns accounting policies with those of comparable companies. The aim is to show the earnings a typical buyer could expect from the business.

You must also decide which level of value applies. A controlling interest, a marketable minority interest and a non-marketable minority interest are different things. The discounts and premiums must match the method used and the stake being valued. Also, the purpose matters: a sale, a tax filing and a litigation case can each call for a different standard of value.

Key formulas to remember

Normalised earnings: Normalised earnings = Reported earnings ± adjustments for non-recurring items, owner compensation to market level, related-party items and policy differences; Adjust pre-tax, then reflect tax if the question asks for net income. Keep only recurring, business-related items.
Owner compensation adjustment: Adjustment = Owner pay actually charged − Market pay for the role; If owner is overpaid, add the excess back to earnings. If underpaid, deduct the shortfall.
Discount for lack of marketability (DLOM): Value (non-marketable) = Value (marketable) × (1 − DLOM); Applied to a marketable value of the stake. Apply it only when the base value is marketable. Do not apply it twice or to a value already reflecting illiquidity.
Discount for lack of control (DLOC): DLOC = 1 − [1 ÷ (1 + Control premium)]; Converts a control premium into the matching minority discount. Use only when moving between control and minority levels.
Control premium from a stake value: Value (controlling) = Value (minority) × (1 + Control premium); Applies when the starting value is a marketable minority value, such as from public comparables.
Combined adjustment: Value (non-marketable minority) = Marketable control value × (1 − DLOC) × (1 − DLOM); Use this form only when the base is a marketable control value being converted to a non-marketable minority value. Apply DLOC only if the base is a control value, and DLOM only if the base is marketable. If the base is already minority, apply DLOM alone. Multiply sequentially, never add the discounts.

How to solve Private vs Public Company Valuation Issues questions

Use this order for any item set on private versus public valuation issues. Read the vignette for the purpose, the stake and the data quality first.

1Identify the purpose and the stake: control or minority, marketable or not, and the standard of value requested.
2List the private-company issues stated in the vignette: limited data, illiquidity, concentrated ownership, key person, owner-run items.
3Normalise earnings or cash flows. Remove one-offs, set owner pay and related-party items to market, and fix policy differences.
4Decide how risk enters: higher discount rate, lower cash flows, or an explicit discount. Do not count the same risk twice.
5Pick the method and note the level of value it gives. Public comparables give a marketable minority value. A DCF with control-based cash flows gives a control value.
6Apply the needed premium or discount to reach the requested level, multiplying sequentially.
7Check the result for consistency: no double counting, the stake matches the answer, and the direction of each adjustment is right.

Quickest way: Normalise, then match the level of value

When to use it: Use when the item set gives a list of owner and one-off items and asks for adjusted earnings or a stake value.

Start with reported earnings.
Scan each item: one-off? Remove it. Owner pay different from market? Replace with market. Personal expense? Add back.
Tax-effect only if net income is asked.
Note the level of value the method gives.
Apply DLOC or DLOM only if the requested stake differs, and multiply in sequence.

Common mistakes in Private vs Public Company Valuation Issues

Adding back owner pay in full instead of only the excess over market pay
Students treat any owner pay as non-business cost.
Fix: Add back only the amount above market pay for the role. A replacement manager would still be paid.
Removing recurring items because they look unusual
A large cost or gain draws attention, even when it happens every year.
Fix: Ask if it is likely to recur. Only non-recurring items are removed.
Applying DLOM and a higher discount rate for the same illiquidity risk
Both seem to deal with extra risk.
Fix: Decide where each risk goes. If the discount rate already includes an illiquidity premium, a separate DLOM double counts.
Adding DLOC and DLOM together
Discounts look like simple percentages to sum.
Fix: Multiply: (1 − DLOC) × (1 − DLOM).
Applying a control premium to a value that is already a control value
Students forget which level the method yields.
Fix: Label each method's level first. DCF on adjusted, control-level cash flows is already control; public comparables are minority.
Ignoring key person risk or treating it as a discount to apply to every case
It is mentioned as a concern but not assigned a treatment.
Fix: Reflect it in cash flows or the discount rate when the vignette shows dependence. Avoid double counting with other adjustments.

Worked examples

Example 1

Vignette: Anand Tools Ltd is a private manufacturer valued by an analyst for a sale of the whole company. Reported pre-tax earnings are $1,200,000. The founder-owner is paid $450,000 although a replacement manager would cost $300,000. The company recorded a one-off lawsuit gain of $150,000. The company pays $60,000 yearly for a vehicle used personally by the owner's family, with no business use. Tax rate is 25%. Q1: What is normalised pre-tax earnings? Q2: What is normalised net income?

Show the solution

Start: $1,200,000.
Owner pay is $150,000 above market ($450,000 − $300,000), so add back $150,000.
The lawsuit gain is non-recurring, so subtract $150,000.
The vehicle cost is personal with no business use, so add back $60,000.
Normalised pre-tax earnings = 1,200,000 + 150,000 − 150,000 + 60,000 = $1,260,000.
Tax at 25%: 1,260,000 × 0.25 = $315,000.
Net income = 1,260,000 − 315,000 = $945,000.

Answer: Q1: $1,260,000. Q2: $945,000.

Example 2

Vignette: An analyst values a 30% non-controlling stake in Kaveri Foods, a private firm. Guideline public companies imply a marketable minority equity value for the whole firm of $80 million. The analyst judges a DLOM of 20%. The stake is not marketable. Q1: What is the value of the 30% stake before any discount? Q2: What is the value of the stake after DLOM? Q3: Is a control premium needed?

Show the solution

Public guideline multiples give a marketable minority value, so the whole-firm value is $80 million.
Stake before discount = 30% × 80 = $24 million.
After DLOM: 24 × (1 − 0.20) = $19.2 million.
The stake is a minority one and the base value is already at the minority level, so no control premium is added and no DLOC applies. Only DLOM is needed.

Answer: Q1: $24 million. Q2: $19.2 million. Q3: No, the base value is already minority level and the stake is minority.

Exam tips

Read the vignette for the stake and purpose first. Most wrong answers come from using the wrong level of value.
For normalisation questions, mark each item as recurring or non-recurring and at-market or off-market before calculating.
Know the direction: overpaid owner increases adjusted earnings; underpaid owner reduces them.
When a question gives both a control premium and a DLOM, check which one the base value needs. Often only one applies.
Watch for double counting between the discount rate, cash flow forecasts and explicit discounts.

Private vs Public Company Valuation Issues in other exams

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

Private vs Public Company Valuation Issues: frequently asked questions

What are the main challenges in private company valuation?

Limited and unreliable information, no market for the shares, concentrated control, key person dependence and owner-driven distortions in earnings. Each affects either the cash flows, the discount rate or the discounts and premiums applied.

How do you normalise earnings for a private company?

Remove non-recurring items, adjust owner pay and related-party transactions to market levels, remove personal expenses and align accounting policies with comparables. The result shows earnings a typical buyer could expect.

Does a private company always get a marketability discount?

No. It depends on the method and the stake. If the base value comes from marketable public comparables, a DLOM may be needed. If the discount rate already includes an illiquidity premium, adding DLOM can double count.

How do key person and control issues affect value?

Key person dependence can lower expected cash flows or raise the discount rate. Control affects who can change strategy, pay and distributions, so a controlling stake may be worth more than a minority stake of the same proportion.