Calculating WACC for Private Company with 100% Equity
Does anyone know how to calculate the WACC (or any appropriate discount rate) for a startup service company with no debt, funded through a mix of employee capital and venture capital? I don't think this matters, but no dividends are paid over 5 year projections (it's a growing company).
WACC calculator for private companies
If attempting to find WACC for a private company with no debt, you need to solve for the capital asset pricing model. However, as a private company there will not be a beta so you will need to look at comparable public companies, take their betas and unlever them and re-lever them based on the capital structure of the company. Our users explain below:
For reference the CAPM model is: risk free rate + Beta *(market risk premium)
It's the same way you would calculate the WACC for any other company. So you have no debt, and I assume no preferred stocks, so all you need is the CAPM. You get the Beta from similar companies off of Bloomberg, unlever them, take the median, then lever back (in this case, whatever you get unlevered will be your levered beta since you have no debt)Then you multiply the beta with market risk premium then you need to add in size premium or other thing you think is appropriate since it's a start up.
Check out a slide below for finding a private company’s beta using the unlevering process. This slide comes from a deck prepared by Professor Damodaran of NYU.
Source: https://www.slideshare.net/gfumagalli/private-company-valutation
Also you can learn more about the levering and unlevering of betas with the below video:
However, one user feels that calculating WACC might not be appropriate in the given situation.
Assuming this is still a small company and potentially not even profitable. I wouldn't say that it's appropriate to use a standard WACC methodology. The VC is looking for huge returns, think 40%+, as are the other investors.Try to estimate what the value of the company will be in 5 years, then discount that value to today's estimated value (based on VC investment). The discount rate may give you a good sense of the cost of equity - and the VC's expected return on equity.
Read More About WACC on WSO
- Weighted Average Cost Of Capital (WACC) Definition
- Cost Of Capital Vs. WACC
- What Is "WACC" Or The Weighted Average Cost Of Capital?
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Honestly, you usually can't do a dcf on a startup. But if you really wanted...here are the steps
It's the same way you would calculate the WACC for any other companies. So you have no debt, and I assume no preferred stocks, so all you need is the CAPM. You get the Beta from similar companies out of Bloomberg, unlever them, take the median, then lever back (in this case, whatever you get unlevered will be your levered beta since you have no debt)
Then you multiply the beta with market risk premium, which last time i checked was about 7%? then you need to add in size premium or other thing you think is appropriate since it's a start up.
Follow-up question for you if you're still around ...
What would you do with a private company that has a small amount of debt, but their equity is relatively meaningless. That is to say, the only equity is scraped out from ownership distributions. To simplify:
Assets: Current Cash: $2,000,000 Debt Cash: $1,000,000
Credit Cash: $950,000
Liabilities: Current Debt: $2,000,000 + Equity: Credit Retained: Earnings: $1,000,000 Debit Ownership: Distributions $950,000
I know the WACC formula and understand the how to get the right Beta ... but when I am calculating the (E/(E+D)) or (D/(E+D)) part of the formula what am I supposed to do? I have read several times to use the market value of debt and equity; however, I am not sure how that applies here. What do I do to get the right equity number? Ownership distributions could be anything.
Assuming this is still a small company and potentially not even profitable. I wouldn't say that it's appropriate to use a standard WACC methodology. The VC is looking for huge returns, think 40%+, as are the other investors.
Try to estimate what the value of the company will be in 5 years, then discount that value to today's estimated value (based on VC investment). The discount rate may give you a good sense of the cost of equity - and the VC's expected return on equity.
How would you find the WACC of a private company with no comparable public company? (Originally Posted: 01/11/2015)
Was thinking about interview questions and this one got to me.
Interested in this as well
There's always a comparable company. You're just not looking hard enough.
Comparable company for WSO?
I'm assuming this interview was for an SA role? Many ways to answer this. You'd want to ask clarifying questions or make some assumptions. If you can garner that the business has different revenue segments, a simple answer would be to break down the company into segments and get comps for each one.
Going from first principles, I'd approach it as follows:
Once I have an unlevered beta from that process, I can relever it for the proposed capital structure.
The only 'unknown' then remaining is the estimated cost of debt. For that, I can just take my cash flow forecasts, industry outlook and qualitative analysis on competitive position and talk with my bank's ratings desk, who will tell me where they think it would rate (say, B1/B). I'd then take a look at the latest DCM newsletter issued by my DCM team, or talk to the DCM team itself, to get an estimate of the spread that a credit of that rating, industry, EBITDA size, competitive position etc would have to pay.
Or else I'd just check what the actual cost of debt is for the existing company (assuming my valuation is for a deal which won't involve a change in capital structure and new debt, which is often not the case).
All the other WACC inputs - proportions of debt and equity funding, market risk premium, risk free rate, tax rate - are knowns.
If this is a mature company in a mature industry, I could also use the assumption that WACC = RONIC and look at what RONIC the company has achieved in the last few years. From distant and possibly incorrect memories of my MFin, that's based on the assumption that, in the long run, supernormal profits aren't possible. I don't think that's a safe assumption for a realistic DCF.
HOWEVER, in practice, what you do on an advisory gig is:
Middle Market M&A - WACC calculation for private companies question (Originally Posted: 03/23/2015)
Hi All,
I'm at a confusion point for private company valuation. Up until now I've always used the current proportion of equity and debt in the calculation of WACC. However, someone told me to use the pro forma weight of D/E.
I'm a bit confused as typically you use the WACC rate as the discount rate in a DCF which then determines the enterprise (along with public comps and precedent transactions). This ends up being circular since you can't get the expected value/weight of equity until you do an valuation...which uses the WACC.
The Macabus definition says the same thing, use he market value of equity, which is basically the enterprise value minus debt.
Someone please straighten me out as I've looked it up and even in the old modeling tutorials we had in training says just link up the current equity and current debt when calculating the weightings of debt and equity....
use book value or PF equity. this is standard practice.
Yeah that is what I thought, but he insists on using implied equity...
Book value of equity.
WACC on Private w/Public Debt (Originally Posted: 04/02/2011)
if you had to estimate a discount rate or wacc for a private company that has public debt and don't have any other resources available to you besides the financials of the company how would you estimate it for the purposes of a DCF?
I understand that in a typical situation where you have a bloomberg terminal and comps you would take the beta of similar companies, unlever and then relever according to target capital structure of the subjec company, however that information is not available.
Think case study interview.
Orchid
start by looking at the growth profile and relative size of the company. The higher the growth projections and smaller the revenue base, the higher the WACC should be, ceteris paribus. Growth / VC stage companies can be in the 20s - 40s or even beyond for early stage deals, while more mature companies are usually WACC generally. Wouldn't necessarily be true if the company was performing poorly and breaching covenants though, so watch out for that.
hope this helps.
All things being equal.
Help with interview question: "What is the WACC of a gym?" (Originally Posted: 10/13/2009)
So at the end of my finance interview today, the analyst asked me what discount rate I would use to value a privately-owned gym?!
I wasn't sure of the answer and I think I messed up on it. First, I am not sure how using the WACC differs for a private firm versus a public firm.
He also asked me what benchmark I would use in the CAPM when valuing the gym... when I told him the S&P500, he just looked at me weird and didn't say anything...
Can someone help me understand what the interviewer was looking for here? How would you have answered the question?
For a public co beta is easily available. Not so for a private co. Also, you might have to lever beta depending upon the capital structure of your private company viz-a-viz the beta of a comparable public co ( which you may use )
Basically, break wacc up into each of its components and come up with an estimate or range of each item - always have reasons for each estimate
What should the cost of debt be What should the equity risk premium be etc..
Now, as a general thought, the valuation of a private co will be around 20% discounted to the value if it were a public co. ( Liquidity discount )
Also, the kind of assets will influence this discount %. High quality/ very liquid assets will result in a lower % and vice versa
Thanks.
For the "risk premium" part of the CAPM, instead of mentioning the S&P500, should I instead suggest using a "gym industry premium" based on the excess returns of the gym industry over the risk-free rate?
I know no such gym industry index exists, but I thought it might be a good answer to let the interviewer know I understand the concept.
Any advice?
no you idiot
The risk is captured by beta. The difference between the market and the risk free rate will be the same. You could also add a separate risk premium but don't change the (Rm -Rf) part.
its the cost of capital
its the cost of capital
I was asked a similar question - about valuing a Squash court! I was asked to estimate beta, cost of debt etc and give the interviewer a number.
i would incorporate the obesity rate into the premium
Help - WACC related question (Originally Posted: 09/21/2009)
I was wondering if someone might be able to clarify something for me. My question relates to a WACC analysis.
Suppose I am a large public company who is going to buy a smaller private company with all cash, and the transaction will be cash free, debt free.
Let's say I'm performing a WACC analysis for the potential acquisition based on comparable public companies, and I've calculated the median unlevered betas of my comp set. Since I am buying this company with cash and it is cash free, debt free, does that mean my unlevered and relevered betas will be the same?
Also, would my cost of equity and weighted average cost of capital theoretically be the same?
Are these assumptions correct? If anyone can provide clarification for me regarding the above, I would greatly appreciate it.
Use target gearing to calculate your relevered beta and also the WACC.
From the ghetto....
I was taught to use the optimal debt ratio (as indicated by the industry norm). You don't want the value of the target to be drastically altered by your capital structure decisions.
why would you use the median and not the average
The median stops any outliers from affecting your data.
yeah...since you have no debt...unlevered and relevered betas should be the same.
Yep..WACC would be equal to Re.
Buyside CFA makes an interesting point...not sure though...since your firm is, at the end of the day, debt free....why would you want to use any debt in your assumptions...? I think you're on the right track....
Anyone else care to add?
How would you find the WACC of a private company with no comparable public company? (Originally Posted: 01/11/2015)
Was thinking about interview questions and this one got to me.
Middle Market M&A - WACC calculation for private companies question (Originally Posted: 03/23/2015)
Hi All,
I'm at a confusion point for private company valuation. Up until now I've always used the current proportion of equity and debt in the calculation of WACC. However, someone told me to use the pro forma weight of D/E.
I'm a bit confused as typically you use the WACC rate as the discount rate in a DCF which then determines the enterprise (along with public comps and precedent transactions). This ends up being circular since you can't get the expected value/weight of equity until you do an valuation...which uses the WACC.
The Macabus definition says the same thing, use he market value of equity, which is basically the enterprise value minus debt.
Someone please straighten me out as I've looked it up and even in the old modeling tutorials we had in training says just link up the current equity and current debt when calculating the weightings of debt and equity....
Did you ever get an answer to this? I have a different but related question.
WACC on Private w/Public Debt (Originally Posted: 04/02/2011)
if you had to estimate a discount rate or wacc for a private company that has public debt and don't have any other resources available to you besides the financials of the company how would you estimate it for the purposes of a DCF?
I understand that in a typical situation where you have a bloomberg terminal and comps you would take the beta of similar companies, unlever and then relever according to target capital structure of the subjec company, however that information is not available.
Think case study interview.
Orchid
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