"The Private Company Discount"
      Journal of Applied Corporate Finance, Vol. 12, No. 4,
      Winter 2000

      BY:  ATULYA SARIN
              Santa Clara University
              Dept. of Finance
           JOHN KOEPLIN
              University of San Francisco
           ALAN C. SHAPIRO
              University of Southern California

ABSTRACT:
 When appraisers or investment bankers value a private company by reference to an otherwise similar but public company, they typically apply a discount. Most practitioners hold the view that this discount reflects the reduced value due to the relative illiquidity of private companies. They use estimates of this discount based on two types of empirical studies. One set of studies compares the prices at which publicly traded companies issue restricted shares in private placements to the publicly traded stock price. The argument is that the restricted shares are identical to the publicly traded shares but for trading restrictions and, therefore, the private placement discount must reflect their lack of liquidity. This technique to estimate the private company discount is flawed for at least two reasons. First, the private placement discount could be associated with a variety of factors, of which illiquidity is only one. Second, the private companies may be valued differently because of factors other than liquidity that have caused the firm to continue to stay private rather than choosing to list on an exchange. The other set of studies compares the prices at which companies go public with the prices at which shares were sold prior to the IPO. These studies suffer from some serious biases. For one thing, most of these private transactions are with insiders. Most importantly, we only observe these pre-IPO discounts for companies that are successful enough to go public. Unsuccessful firms never enter the sample.

 We present an alternative framework to estimate this discount. We compute four valuation multiples for a set of private transactions and a comparable set of public transactions. We then compare these two sets of multiples for both domestic and foreign firms and use the differences between the two as our measure of the private company discount. We find that for both the domestic transactions and foreign transactions, the discount for earnings multiples is statistically and economically significant. The discount using the book value multiples is significant only for domestic transactions and the discount using the revenue multiples is not significant for either the domestic or foreign transactions. We also estimated cross-sectional regressions to account for differences in size and historical growth rates between the private and public companies in our sample. Even after including these other explanatory variables, our results continue to indicate a statistically and economically significant private company discount.

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 Contact:  ATULYA SARIN
   Email:  Mailto:asarin@scu.edu
  Postal:  Santa Clara University
           Dept. of Finance
           Leavey School of Business and Administration
           Santa Clara, CA 95053  USA
   Phone:  408-554-4953
     Fax:  408-904-4498
 Co-Auth:  JOHN KOEPLIN
   Email:  not available
  Postal:  University of San Francisco
           Department of Accounting
           2130 Fulton Street
           San Francisco, CA 94117  USA
 Co-Auth:  ALAN C. SHAPIRO
   Email:  not available
  Postal:  University of Southern California
           Department of Finance
           Los Angeles, CA 90089  USA