recently got asked “Company A is worth a billion dollars and public; Company B is worth 100 million and private. However, Company B is priced at a premium. assume the companies are in the same industry. Why would this be?”
How would you guys answer this ?
Well it comes down to why and what you value a company on. Private markets are less liquid but traditionally valued things could be high potential for growth in the future. The word ‘premium’ is odd though, because maybe there’s a premium on the COE for being illiquid and not necessarily positively for being private if that makes sense. But usually squestions like this is something like growth potential
Faster growth rate, proprietary technology, a better brand, more loyal customers. Example: Beyond Meat and Impossible Foods... Impossible has a GMO heme which enables them to create better products than BM.
Apart from what others said above, my first answer to this question would be: "Priced at a premium based on what? P/B, P/S, P/E, EV/EBITDA". If this is the way the question was asked, with no other info, it's confusing.
Also, smaller companies (private or public), tend to command lower multiples than listed ones, as they are seen as higher risk. The illiquidity matters less if you are looking at the entire company vs a share: a share can be illiquid if private and liquid if listed. However, if you have 50% of a listed firm and want to sell, it is almost as illiquid as 50% of a private company.
Clearly one is backed by SoftBank.![]()
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I wanted to say the private one is full of VC money :))
This is a medium to advanced level IB technical that usually tech boutiques will ask. The main answer is illiquidity premium and higher risk. The fuller explanation can be derived from the above users' explanations.
EDIT: The above answer is incorrect. I was thinking about why the cost of equity for private companies might be higher than that of public companies. An increased cost of equity leads to a higher WACC, which then leads to a discounted valuation. Hominem is correct as usual. Thank you for noticing!
Is there a source you can think of for more advanced and tech specific questions such as these? I've seen the M&I guide but those questions seem pretty straight forward.
This is not correct. Illiquidity and higher risk lead to a discount in valuation, not a premium.
The main reason that the smaller, private company would command a premium valuation vs. the larger company is that the smaller company has higher growth potential.
You're both technically right. https://www.investopedia.com/terms/l/liquiditypremium.asp
No, we are not both technically right. Let's say that there is an asset out there that is freely tradeable worth $100. Now, let's say that you have the same asset, but it is illiquid (i.e., you can't get rid of whenever you want). As an investor, would you pay more or less for this? The answer is that you would pay less. This leads to a DISCOUNT in valuation. By paying less for this asset, investors are compensated extra for taking on the risk of illiquidity in this asset. That is what is meant by liquidity premium.
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