How Much is a Privately-Held Business Really Worth?

Sorry to say, it is a common misconception among owners of privately-held businesses that their company is worth the same as a comparable publicly traded company.

Just Not True

Unfortunately, not only is this belief not true, the amount of the difference in value between the two types of firms can come as a huge shock to the uneducated business owner.

So if you are a business owner and reading this, prepare to get some education AND learn the solution to this problem.

Reasons for Difference in Value

There are a number of reasons for the significant difference in value between public and private companies of comparable size and income.

First, but not primary, is the difficulty in evaluating a private company’s financial and other management records.  These are not as transparent as those of a publicly-traded firm which has to meet stringent and regular reporting requirements.

Liquidity Seriously affects Value

The second and bigger reason is that of “relative liquidity.”  “Liquidity” is defined as the ease with which an asset can be quickly bought or sold without affecting the asset’s price.

A public firm can be bought or sold quickly through its publicly traded shares on a stock exchange.  Hence, it has a very high liquidity.

While a private company is not precluded from having shareholders. these shares cannot be traded at all on public exchanges like the NYSE or the CHX.  Therefore, a privately-held company has a much lower level of liquidity.

The Chartered Financial Analyst Institute cites relative liquidity as a factor in the difference between public versus private valuations.

30-50% Difference in Value

The bad news is that numerous market research studies show this relative liquidity difference between comparable private and public firms, referred to as the DLOM (Discount for Lack of Marketability), to be in the 30 to 50% range.

This is a serious loss of value for a business owner.

What to Do?

The challenge for many privately-held small and mid-size companies is how to overcome their liquidity discount and increase their value.

There have been challenges.  Private companies almost always have more difficulty in raising capital.  They may not qualify for certain types of equity funding or for bank loans.

In the past, many such companies were reluctant or even unable to go public due to the high cost and protracted length of time it took to register with the Securities and Exchange Commission (SEC).

Legislative Changes Make it Easier to Go Public

However, relatively recent regulatory changes have made it possible for privately-held companies go public quickly and for a significantly reduced cost.

The JOBS Act (Jumpstart Our Business Startups Act) was signed into law in 2012.  This legislation was passed as an effort to create an environment in which companies can raise public capital more easily.

Accordingly, in June of 2015, the SEC launched amended rules, called Regulation A+.

Regulation A+ provides the opportunity for small and medium-size companies to raise up to $50 million of equity capital easier than ever before.

Lower Cost, Less Time, Fewer Regulations to Go Public

Here are some of its features:

  1. The great thing is that a Regulation A+ filing is comparably low cost and takes less time than a traditional IPO with the SEC.

For example, a Regulation A+ issuer could safely budget only $75,000 and three months to secure SEC approval for their offer.   This is a tenth of the cost and time needed before this regulatory change.

  1. New under the regulation is a preemption of state security requirements for companies which fall within a specific capital-raising range. This means that these companies will no longer have to file with each individual state in which they propose to do business.
  1. A company can use the “testing the waters” provision of the regulation that allows a company to determine whether its offer will attract potential investors before it has filed anything with the SEC or even undergone the accounting and legal expense to prepare a filing.

Increase the Value of Your Company from 30 to 50%

The upshot is that private business owners can increase the value of their firms by 30 to 50% by going public at a reduced time and financial commitment.

It only makes sense for a small business owner to consider this approach as part of a comprehensive plan to increase corporate value.

If you want more information, BVC can answer all your questions.  We are the Value Creation Experts for the Innovation Economy.  Fill out our online form or call 1-800-856-6780.

 

 

Ron Everett
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Ron Everett has served as a merger and acquisition (M&A) advisor and corporate valuation expert to more than 3,500 companies since 1984. He has 25+ years of specialized expertise in valuing and pricing companies for purchase or sale, initial public offerings, private placements and recapitalizations.