Principles of Private Firm Valuation

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T

he intended audience for Principles of Private Firm Valuationis CPAs,

valuation analysts, and CFOs of private firms. Many of the valuation

issues these groups deal with are uniquely related to accurately measuring

the value of private firms. Several well-known academic and practitioner

books deal with the valuation of both public and private businesses. Princi-

plesadded value is that it integrates academic research results with on-the-

ground practical experience to provide a more disciplined guidance on how

to address several unresolved issues in the arena of private firm valuation:

■ Assessing which valuation method is most accurate.

■ Estimating the size of the marketability discount; a reduction in value

due to the inability to convert to cash at fair market value in a cost-

effective way.

■ Estimating the value of control and its implication for valuing minority

interests in a private firm.

■ The influence of taxes on firm value and, specifically, whether S corpo-

rations are worth more than equivalent C corporations.

■ How best to estimate a private firm’s cost of capital.

The purpose of valuing private firms varies. Although a valuation is

generally required prior to a private firm being transacted, the majority of

private firm valuations are completed for tax-related reasons. For example,

equity in a private firm that is part of an estate needs to be valued in order

to calculate the estate’s tax liability. Similarly, when ownership interests of a

private firm are gifted or when they represent a charitable donation, their

monetary value needs to be determined, and these valuations typically

accompany the donor’s tax return. Hence, these valuations are subject to

audit by the Internal Revenue Service (IRS).

IRS challenges to business valuations are often adjudicated in Tax

Court. As a result, there have been numerous Tax Court rulings that

opine on technical valuation issues. Often, these rulings run counter to

valuation practice, which places added pressure on valuation analysts to

apply methodologies that are consistent with finance theory and objec-

tive empirical research. While the role of the Tax Court is to adjudicate,

Preface

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