PVT Valn 2016

BM(201416)Batch,XLRI
8/23/2015
Valuation of Private Companies
8/23/2015
Th process off valuing

l i private
i
i iis
The
companies
no different from the process of valuing
public companies.
When valuing private companies, you face
two standard problems:
There is no market value for either debt or

equity
The financial statements for private firms are
likely to go back fewer years, have less detail
and have more holes in them. The financial
statements need to be modified.
Market Values as inputs

1.
2.
8/23/2015
Debt ratios for going from unlevered to levered betas

and for computing cost of capital
Market prices to compute the value of options and
warrants granted to employees
Market value as output

Market price based risk measures
h
h
Shorter
history:
Private firms often have been around for
much shorter time periods than most publicly traded firms.
Different Accounting Standards
Intermingling of personal and business expenses
Separating salaries from dividends
8/23/2015
8/23/2015
P i
Previous
Y
profit
fi fi
i h b
Years
figures might
be
overstated.
Presence of Operating Lease
Has it ben included as an of-balance sheet item?
Assets:
Assets
Divide into Personal and Business
Cars, Office (if home used)
Personal
future
Expenses unlikely to be incurred in
Salary for ghost employees, personal travel

expenses, attending seminars, high salary for the
CEO
Private
8/23/2015
to private transactions:
Buyer buys 100% of the shares

Buyer buys partial stake
Private
to public transactions:
Private to IPO:
8/23/2015
Three key issues:
1.
Neither the buyer nor the seller is diversified.
2.
The investment is illiquid.
3.
Key person value.
8/23/2015
The
value of the business is inversely

proportional to the stature of the key person
in the company.
The buyer buys the company minus the key
person.
If the company can survive without the key
person, the value of the business will be
high.
8/23/2015
Private Company selling textile garments in North India.

60% revenue comes from selling school uniforms.
40% revenue comes from selling ready-made garments in shopping
outlets.
About 100 workers mostly part-time work and stitch the
garments using
g
g single-needle
g
manually-operated
y p
sewing
g
machines.
The company wants to grow and needs digital control

multi-needle quilting machines.
Requires Rs.75 crores. Rs.50 Crores for buying the machines,
building a new factory, etc. and Rs.25 crores for working capital
financing.
financing
A PSU Bank has offered to lend Rs.25 crores at 11%, provided the
remaining amount comes in equity.
8/23/2015
BalanceSheetofKavitaTextilesPrivateLimited(Figuresin ` Crores)
Profit and Loss Account of Kavita Textiles Private Limited (Figures in ` Crores)
ProfitandLossAccountofKavitaTextilesPrivateLimited(Figuresin
Fortheyearending31Marchof
NetSales
OtherIncome
TotalRevenue
2011
20
1
21
2012
26
1
27
TotalExpenses
RawMaterial
WagesandSalaries
g
SellingandDistributionExpenses
AdministrativeExpenses
Depreciation
Total
8
1
1
1.2
1.1
12.3
10.5
1.2
1.5
1.3
1.1
15.6
2
1.7
5.0
2.4
2.3
6.8
Interest
ProvisionforTax
ProfitafterTax
Cash tax rate: 25%
Ason31Marchof
2011
2012
ShareCapital
ReservesandSurpluses
3
10
3
12.6
TotalLiabilities
18
20.6
CashinBank
AccountsReceivables
Inventories
LoansandAdvances
TotalCurrentAssets
5
1
8
1
15
7
2
9
1
19
AccountsPayable
Provisions
Total Current Liability
TotalCurrentLiability
2
1
3
4
1
5
12
14
8
2
6
9.7
3.1
6.6
18
20.6
LoanfromBank
NetCurrentAssets
GrossFixedAssets
Less:AccumulatedDepreciation
NetFixedAssets
TotalAssets
10
8/23/2015
Kavita
and her husband currently draw salary

of Rs.100,000 each p.m. For an equivalent
public company, the salary would be
Rs 500 000
Rs.500,000.
Revised wages and salaries expenses will increase

to Rs.1.2 cr + 400,000 12 2 = Rs.2.16 crores.
Selling
and Distn expenses and admin.

Expenses are probably overstated as they
might include some personal expenses. I
restate at Rs.2 crores.
11
8/23/2015
ProfitandLossAccountofKavitaTextilesPrivateLimited(Figuresin ` Crores)
NetSales
OtherIncome
TotalRevenue
2011
20
1
21
2012
26
1
27
2012Revised
26
1
27
TotalExpenses
RawMaterial
WagesandSalaries
Depreciation
Total
8
1
1
1.2
1.1
12.3
10.5
1.2
1.5
1.3
1.1
15.6
10.5
2.16
1
1
1.1
15.76
Interest
ProvisionforTax
ProfitafterTax
2
1.7
5.0
2.4
2.3
6.8
2.4
2.2
6.6
12
CompanyName
Company
Name
SpiceIslandsApparelsLtd.
ViratIndustriesLtd.
CitymanLtd.
GIVOLtd.
Samtex Fashions Ltd
SamtexFashionsLtd.
CompanyName
ViratIndustriesLtd.
Cityman Ltd
CitymanLtd.
GIVOLtd.
SamtexFashionsLtd.
Median
8/23/2015
Cash Debt
47.8
15
10.8 14.8
0.1 119.5
20.5 36.9
11 4 439.1
11.4
439 1
MktCap
Enterprisevalue
(` Crores) P/E
(EV) (` Crores) EV
EV/EBITDA
/ EBITDA Beta
P/E P/B
P/B (EV)(`
51.13 8.52 0.35
66.13
0.11 0.56
80.25 5.39 0.87
95.05
3.94 0.54
125.9 NA NA
245.4 NA
0.85
173.07 37.62 0.6
209.97
13.44 1.19
173 25 91.18
173.25
91 18 0.42
0 42
612 35
612.35
9 79 0.73
9.79
0 73
Cash
47.8
10.8
01
0.1
20.5
11.4
Debt
15
14.8
119 5
119.5
36.9
439.1
MktCap
(`Crores)
51.13
80.25
125 9
125.9
173.07
173.25
Beta NetDE BetaU

0.56
0.64
1.08
0.54
0.05
0.52
0 85
0.85
0 95
0.95
0 50
0.50
1.19
0.09
1.11
0.73
2.47
0.26
0.73
0.09
0.52
13
8/23/2015
Market Value of Equity = 17 Rs.6.6 crores = Rs.112.71

crores.
Here, 17 is the median Earnings multiple and Rs.6.6
crores is the adjusted net income of the company.
L U 1 (1 t )
Ke: 8.2% + 0.51 7.13% =

11.84%.
0.52 1 0.75
112
.
71
0.51
14
8/23/2015
Fi
th
i l assumes people
l lik
K it
Finance
theory
simply
like Kavita
to be irrational.
Typical shortcuts used:
Double the beta: Ke will equal 15.47% (vis--vis

11.84%)
Double the Ke: Ke will equal 23.67%
Use Market Model
ri ,t i i rm ,t errors
2
i2 i2 m2 errors
15
CompanyName
ViratIndustriesLtd.
CitymanLtd.
GIVOLtd.
d
SamtexFashionsLtd.
Non-systematic
8/23/2015
TotalRisk SystematicRisk NonsystematicRisk

37.71%
3.07%
34.63%
31.67%
2.86%
28.82%
31.20%
7.08%
24.12%
37.84%
13.88%
23.96%
51.68%
5.22%
46.45%
risk around 5 times
systematic
t
ti risk.
i k
Adjusted Ke will equal 71%.
I use 23.67% here.
16
8/23/2015
Cost
C t
off D
Debt:
bt 11%
Cost of Equity: 23.67%
Tax Rate: 25%
WACC
FreeCashFlow
TerminalValue
PVofFCF
Less:Debt
AddCash
dd h
EquityValue
2
112 .7
0.11 (1 0.25 )
0.2367 23 .95 %
2 112 .7
2 112 .7
7.68
7.26
9.53
12.25
14.90
17.23
135.91
77.15
5
7
79.15
The value (ignoring Non-systematic risk) would have been Rs.459.38

crores.
17
They
8/23/2015
are illiquid. Investors take illiquidity
risk.
Not a diversifiable risk. So (the risk) deserves a

premium.
Using
U i g
25% di
discount,
t th
the value
l off Kavitas
K it
equity comes to 0.75 Rs.79.15 crores =
Rs.59.36 crores.
Not bad for (reported) net worth of Rs.15.6

crores.
18
8/23/2015
Expanding
beyond north India. Growth will

slow down in the beginning.
KTPL has plans of using automated machines
for doing a large part of the stitching.
The wages and salaries expenses will not increase

in line with the sales.
Need
to hire more managers to take care of

operations. Private investors look for
COO,
Director
COO Di
t (Marketing)
(M k ti g) and
d Auditor
A dit (CA)
Selling
and distribution expenses will be high

in the beginning.
19
8/23/2015
ProfitandLossAccountofKavitaTextilesPrivateLimited(Figuresin ` Crores)
NetSales
OtherIncome
TotalRevenue
TotalExpenses
Total
Expenses
RawMaterial
WagesandSalaries
Depreciation
Total
Interest
ProvisionforTax
ProfitafterTax
2012Revised
26
1
27
2013E
50.00
6.15
56.15
2014E
80.00
2.69
82.69
2015E
120.00
4.26
124.26
2016E
150.00
6.28
156.28
2017E
180.00
9.38
189.38
10.5
2.16
1
1
1.1
15.76
20.00
3.82
3.00
1.90
5.27
33.98
32.00
5.53
4.80
3.04
8.56
53.92
48.00
7.77
4.56
4.56
7.96
72.86
60.00
9.61
5.70
5.70
7.47
88.48
72.00
11.54
6.84
6.84
7.06
104.27
2.4
2.2
6.6
5.15
4.3
12.8
5.15
5.9
17.7
5.15
11.6
34.7
5.15
15.7
47.0
5.15
20.0
60.0
20
8/23/2015
FreeCashProjectionsforKavitaTextilesPrivateLimited(Figuresin ` Crores)
2012Revised
2013E
2014E
2015E
2016E
2017E
10.24
2.56
7.68
1.10
8.78
16.02
4.00
12.01
5.27
17.28
26.08
6.52
19.56
8.56
28.11
47.14
11.79
35.36
7.96
43.32
61.52
15.38
46.14
7.47
53.61
75.73
18.93
56.79
7.06
63.85
Capex
InvestmentinNoncashworkingcapital
GrossInvestment
1.10
0.00
1.10
50.00
14.15
64.15
5.00
0.37
5.37
5.00
10.76
15.76
5.00
8.07
13.07
5.00
8.07
13.07
FreeCashFlow
7.68
46.87
22.74
27.56
40.54
50.78
NetOperatingIncome
Less:AdjustedTax
NOPAT
Add:Depreciation
GrossCashFlow
21
Debt
ratio has changed now.
New Debt: Rs.30 crores. Net debt: Rs.23 crores.

New Equity: Rs.112.71 (59.36?) + Rs.50 crores.
Net Beta = 0.575
New Ke = 12.3%
12 3%
New
8/23/2015
investors may be diversified.
I use 20% as the Ke here.
Cost
of equity is a negative function of size

off the
(Fama and
th company (F
d French,
F
h 1993)
WACC
23
162.71
0.11 (1 0.25)
0.2 17.52%.
23 162.71
23 162.71
22
8/23/2015
Implied
Equity Value: Rs.345.67 Crores

Illiquidity Adjustment: Rs.345.67 crores (10.25) = Rs.259.25 crores.
This is the post-money value.
Pre-money value is Rs.209.25 crores.
30 Lakh shares outstanding.
Implied value per share = Rs.864 per share.
New investors will be issued 0.06
0 06 crore
shares.
23
8/23/2015
BalanceSheetofKavitaTextilesPrivateLimited(Figuresin ` Crores)
Ason31Marchof
2012Revised
2013E
2014E
2015E
2016E
2017E
LoanfromBank
30
30
30
30
30
30
ShareCapital
ReservesandSurpluses
3.6
62
3.6
74.8
3.6
92.5
3.6
127.2
3.6
174.1
3.6
234.1
95.60
108.36
126.08
160.77
207.75
267.71
CashinBank
AccountsReceivables
Inventories
LoansandAdvances
TotalCurrentAssets
82
2
9
1
94
35.88
3.85
25.00
1.95
66.68
56.78
6.16
27.68
3.12
93.74
83.67
9.24
41.52
4.68
139.11
125.05
11.55
51.90
5.85
194.35
179.01
13.86
62.28
7.02
262.17
AccountsPayable
Provisions
TotalCurrentLiabilityy
4
1
5
7.70
1.95
9.65
12.32
3.12
15.44
18.48
4.68
23.16
23.10
5.85
28.95
27.72
7.02
34.74
NetCurrentAssets
89
57.03
78.30
115.95
165.40
227.43
GrossFixedAssets
Less:AccumulatedDepreciation
NetFixedAssets
9.7
3.1
6.6
59.70
8.37
51.33
64.70
16.92
47.78
69.70
24.89
44.81
74.70
32.35
42.35
79.70
39.41
40.29
95.60
108.36
126.08
160.77
207.75
267.71
TotalLiabilities
TotalAssets
24
8/23/2015
Unlikely to affect value here as both Kavita and

her husband will continue in this business.
In a normal case, if the key person leaves:
Enter into a no-compete agreement
25
8/23/2015
The
investors are clearly diversified.

The reporting and information disclosure
requirements shift to reflect a publicly
traded firm.
26
The proceeds from an IPO can be
8/23/2015
Taken out of the firm by the existing owners

Used to pay down debt and other obligations
Held as cash by the company to cover future reinvestment
needs
How you deal with the issuance will depend upon how
the proceeds are used.
used
If taken out of the firm -> ignore in valuation
If used to pay down debt -> Change the debt ratio, which may
change the cost of capital and the value of the firm
If held as cash to cover future reinvestment needs -> add the
cash proceeds from the IPO to the DCF valuation of the
company.
company
27
8/23/2015
The value of a private business will depend on

the potential buyer (diversification, time
horizon, need for cash, etc.)
If you are a seller of a private business, you will
maximize value,
value if you sell to
One who is well-diversified (or whose investors are)

And who does not think too highly of you (as a person)
28

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PVT Valn 2016

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BM(201416)Batch,XLRI

Valuation of Private Companies

Th process off valuing

There is no market value for either debt or

Market Values as inputs

Debt ratios for going from unlevered to levered betas

Market value as output

Different Accounting Standards

Intermingling of personal and business expenses

Separating salaries from dividends

Has it ben included as an of-balance sheet item?

Divide into Personal and Business

Cars, Office (if home used)

Expenses unlikely to be incurred in

Salary for ghost employees, personal travel

Buyer buys 100% of the shares

Three key issues:

Neither the buyer nor the seller is diversified.

The investment is illiquid.

Key person value.

value of the business is inversely

Private Company selling textile garments in North India.

The company wants to grow and needs digital control

Cash tax rate: 25%

and her husband currently draw salary

Revised wages and salaries expenses will increase

and Distn expenses and admin.

Beta NetDE BetaU

Market Value of Equity = 17 Rs.6.6 crores = Rs.112.71

Ke: 8.2% + 0.51 7.13% =

Double the beta: Ke will equal 15.47% (vis--vis

TotalRisk SystematicRisk NonsystematicRisk

risk around 5 times

The value (ignoring Non-systematic risk) would have been Rs.459.38

are illiquid. Investors take illiquidity

Not a diversifiable risk. So (the risk) deserves a

Not bad for (reported) net worth of Rs.15.6

beyond north India. Growth will

The wages and salaries expenses will not increase

to hire more managers to take care of

and distribution expenses will be high

ratio has changed now.

New Debt: Rs.30 crores. Net debt: Rs.23 crores.

investors may be diversified.

I use 20% as the Ke here.

of equity is a negative function of size

Equity Value: Rs.345.67 Crores

Unlikely to affect value here as both Kavita and

Enter into a no-compete agreement

investors are clearly diversified.

The proceeds from an IPO can be

Taken out of the firm by the existing owners

The value of a private business will depend on

One who is well-diversified (or whose investors are)

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