## **Learning Outcomes**

After reading this article, you will be able to identify and explain the unique valuation issues encountered with private companies and IPOs. You will understand how control premiums, lack of market liquidity, owner-manager dependencies, and special pricing considerations for initial public offerings affect valuation approaches and results. You should be able to recommend appropriate adjustment methods for these scenarios in line with ACCA AFM exam requirements.

## **ACCA Advanced Financial Management (AFM) Syllabus**

For ACCA Advanced Financial Management (AFM), you are required to understand the complexities that arise in valuing private companies and initial public offerings (IPOs). Focus your revision on:

- Applying appropriate asset-based, income-based, and cash flow models to value unquoted entities and IPO candidates
- Identifying and quantifying adjustments for control premiums and minority discounts in private company settings
- Recognising the impact of illiquidity and lack of marketability in private company and IPO valuation
- Explaining how owner dependence, concentrated customer risk, and earnings reliability affect multiple selection and value adjustments
- Advising on IPO pricing, underpricing, and the process of adjusting valuation for costs of going public, regulatory requirements, and expected investor discounts

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which adjustment is typically added when valuing a controlling interest in a private company?  
   a) Illiquidity discount  
   b) Combined value  
   c) Control premium  
   d) Earnings yield

2. True or false? The absence of a quoted share price makes the price-earnings method unreliable by default for private company valuation.

3. Which factor is most likely to cause a minority discount to be applied in a valuation?  
   a) Well-diversified customer base  
   b) Control of board appointments  
   c) Lack of ability to influence company strategy  
   d) Recent IPO

4. Briefly outline two reasons why the value per share in an IPO is often set below the theoretically appraised value.

## **Introduction**

Public company valuations often rely on transparent market data and readily available trading information. However, when valuing private companies or preparing for an Initial Public Offering (IPO), special considerations arise due to illiquidity, owner influence, limited financial data, and regulatory effects. This article examines the necessary adjustments and key issues when valuing private businesses and IPO candidates—knowledge that is frequently tested in ACCA AFM exams.

## **VALUATION ISSUES FOR PRIVATE COMPANIES**

Private entities require special handling because their shares are not listed on a public exchange, which significantly affects how value must be assessed and adjusted.

### Lack of Market Price and Comparable Multiples

Valuers cannot simply use the published share price. Instead, they may use comparable multiples or models derived from similar public companies. However, critical differences must be addressed.

> **Key Term: illiquidity discount**  
> A reduction in a company's calculated value to reflect the lower ease of selling shares in private markets compared to publicly listed firms.
>
> **Key Term: control premium**  
> An amount added to the pro-rata share value based on gaining majority voting rights and control over business decisions.
>
> **Key Term: minority discount**  
> A reduction applied to the value of a shareholding that lacks the ability to influence the company’s management or strategy.

When selecting P/E or EV/EBITDA multiples, adjustments should be made for:

- Limited marketability (illiquidity discount)
- Differences in growth prospects or risk
- Management dependence or customer concentration

### Adjusting for Control and Influence

Private company valuations must consider the viewpoint of the buyer. A purchaser acquiring a controlling stake is often willing to pay a control premium, as this provides the power to direct the company, appoint directors, and set strategy.

Conversely, a small (minority) holding attracts a minority discount because the shareholder cannot influence decisions, access information easily, or enforce major changes.

### Owner-Manager Risk and Earnings Reliability

Private firms often rely on key individuals for customer relationships or operational success. This dependence increases risk and can lead to downward adjustment of valuation multiples or cash flow predictions.

Earnings may be less reliable due to aggressive accounting or personal expenses being charged to the company. Verification and normalization of earnings is necessary before applying multiples.

### Illiquidity and Marketability Discounts

Shares in private companies cannot be easily traded or sold. This justifies a valuation deduction—often estimated using observed discounts between public and private transactions, or specialist studies—commonly ranging from 10% to 40% depending on circumstances.

### **Worked Example 1.1**

A valuer computes the equity value of a 100% interest in a private manufacturer using a peer group P/E ratio and normalized profits, resulting in a calculated business value of \$12 million. However, a 25% minority stake is being valued. What key adjustments should be made?

> **Answer:**  
> First, apply a minority discount to reflect the lack of control (often estimated between 10–30%). Then, subtract an illiquidity discount because the stake cannot be readily sold. Each adjustment must be justified based on relevant comparables and transaction types.

### Asset-Based Methods and Adjustments

Private company net asset value appraisals must distinguish between:

- Book values, which may not reflect true market worth
- Hidden intangibles, or undervalued property or assets
- The value of assembled workforce and customer relationships (sometimes added through a goodwill calculation)

## **IPOs AND SPECIAL VALUATION CONSIDERATIONS**

Valuing a company for an IPO involves projecting a fair price for its first public offering, given additional risks and regulatory costs.

### IPO Underpricing and Investor Discount

> **Key Term: IPO underpricing**  
> The practice of offering shares to the public at a price below calculated fair value to ensure demand, encourage initial trading, and compensate investors for risk.

Range adjustments, including an investor discount, are common in IPOs for the following reasons:

- Uncertainty about market reception and trading liquidity
- Temporary lack of information symmetry compared to established public companies
- Desire to incentivize participation and ensure the offer is fully subscribed

> **Key Term: lock-up period**  
> A set timeframe after an IPO during which insiders are prevented from selling their shares, intended to provide price stability post-listing.

The underwriter, often a bank, analyzes market appetite and typically recommends pricing shares below full appraised value—usually resulting in an initial price surge (the “IPO pop”).

### Adjustments for IPO Costs and Structure

IPO proceeds are reduced by underwriting costs, regulatory fees, marketing, and legal expenses. These outflows must be deducted from gross value in valuation models.

Equity dilution may occur if new shares are issued, lowering the proportional ownership of existing shareholders. Valuation exercises for IPOs must account for this by modeling post-offer share count and ownership structure.

### **Worked Example 1.2**

A technology firm estimates its equity value at \$50 million using forecast free cash flows and peer multiples. The IPO advisor recommends a 20% discount for illiquidity and market uncertainty, and expects 8% of the proceeds to be absorbed by fees.

How should the company set its IPO offer price?

> **Answer:**  
> First, reduce \$50 million by 20% to reflect the marketability discount (\$40 million). Then, subtract a further 8% for costs (\$40m × 0.92 = \$36.8m). The IPO price should be set to raise up to \$36.8 million, divided by the planned post-listing share count.

### Non-Recurring or One-Off Adjustments

In private or IPO valuations, strip out non-recurring gains/losses from profit figures, normalize salaries for owner-managers, and ensure one-time costs do not skew forward-looking estimates.

### **Exam Warning**

> Valuation discounts and premiums are not fixed—state the rationale behind the chosen percentages and relate them to transaction type, bargaining position, and sector standards. Blindly applying textbook figures without justification risks loss of marks.

## **Summary**

Private and IPO valuation requires substantial adjustment from standard listed company models. Adjustments for illiquidity, control, minority holdings, business risk, and IPO-specific costs must be reflected clearly and justified using evidence. The ability to recommend and explain appropriate valuation modifications is frequently examined in ACCA AFM papers.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Identify why market-based models require adjustment for private company and IPO valuations
- Explain and quantify illiquidity, control, and minority discounts or premiums
- Understand normalization of earnings and asset values in non-public companies
- Describe IPO underpricing and its justification
- Adjust calculated values for IPO expenses and share dilution
- Advise on the rationale for chosen adjustment rates and valuation methods

## **Key Terms and Concepts**

- illiquidity discount
- control premium
- minority discount
- IPO underpricing
- lock-up period

Adjustments and special cases - Private company and IPO valuation issues