CONCLUSION

The value of a private firm is the present value of the cash flows it is expected to generate, discounted back at a rate that reflects both the risk in the private firm and the mix of debt and equity it uses. While this statement is identical to the one used to describe the value of a publicly traded firm, there are differences in the way we estimate these inputs for private firms, and even among private firms, depending on the motive for the valuation.

When valuing a private firm for sale to an individual or private entity, we have to consider three specific issues. The first is that the cost of equity, which we have hitherto assumed to be determined purely by the risk that cannot be diversified, might have to be adjusted for the fact that the potential buyer is not well diversified. The second is that equity holdings in private businesses are illiquid, leading to a discount on the estimated value. The discounts on restricted stock issues made by publicly traded firms or the bid-ask spreads of these firms may provide us with useful information on how large this discount should be. The third is that a controlling interest in equity of a private firm can trade at a significant premium over....