liquidity premium in private firm valuation
Question for practitioners: When valuing a private company, is it common to add a Liquidity/transparency/size premiums to the Cost of Equity? or is the practice to value it without premiums, and discount the final value by a liquidity discount?
Thank you
As a financial advisor broking to provide liquidity to shareholders, it would be contradictory to use an illiquidity discount in your CoC.
The illiquidity premium is used for valuation of "Private" firms. Yes you can help private firms raise euiqty through private placement or issuance of bonds, but the execution takes time. A part of liqudity definition is how fast you can sell an asset or access to financing. That said, there is a illiquidity premium in private valuation
Not sure if there is a standard practice for this or not, but in my time in Lower MM M&A we typically added 1-3% ( usually 2%) to CoE as a liquidity discount.
In response to first comment, you'd be using a liquidity discount in the context of valuing a target for a buy-side client or showing a sell-side how buyers would value their company. You're not telling a $20mm revenue company that you'll give them Apple-like daily trading volume. No matter what you do as a banker, you can't create a perfectly liquid market for a lot of public companies, let alone a private company.
At least my firm this summer never used an illiquidity discount as per advice of the valuation experts, even though clients would want to add it as part of a buy-side process (and to pay less fees...).
As often in corporate finance there is no right or wrong answer, both answers can be justified, just like: what discount rate do you use for tax shields?
Good point I guess, if you are working on a buyside deal, they would be eager to apply a discount. They would go to the meeting room trying to justify their lower valuation using the illiquidity. If you are on the sell-side, client is reluctant to apply a discount, but would anticipate that their discount-free valuation, would be challenged by the buyer
I was an analyst at a MM investment bank (think HW, Stephens, Stifel, etc.). TEVs were typically $40mm-$150mm. We would usually apply liquidity/size discounts of 20%-30% on the public comp multiples.
so if the multiples valuation for the private company yielded an EV = 100 then you would you say, assuming a 20% liquidity/size discount, that EV = 100*(1-0.2)= $80 ?
Thanks
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