December 3, 2013
Interviewed by: David Snow
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Valuing a Minority Stake: It’s Complicated

How do you value a minority stake in a private company? What complexities does this minority position bring that makes the valuation different from control? Privcap asked three valuation experts to weigh in.

How do you value a minority stake in a private company? What complexities does this minority position bring that makes the valuation different from control? Privcap asked three valuation experts to weigh in.

Valuing a Minority Stake: It’s Complicated
Best Practices in PE Valuations

David Snow, Privcap:
Today, we are joined by Kevin Vannucci of RSM, John Lambrech of W Capital partners, and Darren Friedman of StepStone Group. Gentlemen, welcome to Privcap today thanks for being here.

  We’re talking all about valuations. This is a hot topic in private equity. It happens every quarter, people do it different ways and all of you are valuation experts so I’m interested in hearing your views on one very interesting topic that is somewhat vexing to people as they try to value a certain kind of  private equity or venture capital investment. And as a minority stake I’m interested in hearing your thoughts on the right way to approach this kind of evaluation, maybe starting with a question for Darren from StepStone. What is challenging or unique about assigning a value to a minority position in a private company that might be different from owning the whole thing?

Darren Friedman, StepStone:
I think the biggest difference depends on what the information rights you have as a minority investor, are you on the board or are you not on the board? Do you see what happens? So for instance, if you own a small percentage on a company you might have information rights to get just financials, whether it’s quarterly or monthly, and that is the available information you utilize to make the assessment on valuation. You place methodologies on those, as opposed to having more information, board packets or actually being in the boardroom, hearing the discussion, a lot more focus on the future. So that might allow you to say DCF is more of the way to value this company cause you have access to projections, you have a better sense from management of the validity of those projections. So I think along that spectrum of information is really where the challenges arise, and I think when we see, cause we have a number of sub 50% ownership positions, and governance and information rights vary on those. And so we see that first hand on which companies are, are, I don’t want to say harder to value, but it takes a little more work to value them. And we might not

have full transparency as the majority owner does, so we can be, we can differ on valuations in those cases.

Snow: John, what are your thoughts on the uniqueness of valuing a minority position?

John Lambrech, W Capital:
I think Darren is spot on. It’s really going to really relate to the depth of information you have, so how can you build your models out? The other aspect that I would add is typically in minority situations you very often have a syndicate of a number of different institutional investors that each may own ten, 15% of the company. It’s very important to understand their mindset, you know, are they perfectly aligned? Has one investor been a minority investor for ten years and maybe got in at the, you know, sub A round, and  their  time  frame  is going to  be  very  different  than someone who maybe came in in the B or the C round. So understanding the motivations and understanding how the different syndicate in minority investments are thinking about the investment is also very relevant and can really dictate the direction of the outcome. So information, as Darren said, very important, but also understanding the nature and the composition of the investor base is very important.

Vannucci: I think along the lines with Darren and John, as they indicated the access to information, but the other thing is the valuation methods and the models you had used. For instance on a discount cash loan income based approach a minority interest shareholder can’t change the cash flow stream, so you’re really stuck with that cash flow stream versus a controlling interest shareholder can make changes. So that’s going to impact the underlying value for a control minority, same with the guideline public method, a GPC method is typically the impact is whether it’s control or minority through the cash flow and not necessarily the multiple coming out. Even though some people might say the GPC method is inherently minority because it’s minority blocks the stock being traded. And then finally on the comparable sales transaction method or precedent transaction method the terms being one and the same is those are typically deals done for entire control of the company. And so if you’re taking that implied multiple and using it on a minority basis some could say that the level of value is slightly different. Then finally another great area between control and minority would be a discount for lack of marketability. So on a minority interest basis some would say you apply a discount for lack of marketability to get down to your ultimate mark, and on a control basis some would say you don’t.

Friedman: And on that point what we look at is we look at what are investors rights to the minority if you have tagalong rights with the majority then you don’t have that issue. Because you could always tag, tag, tagalong on majority sales and you don’t have to rely on just exiting as a pure minority stake in the company. I would also say you know, we’re investors over, over the past 10 or 15 years in a lot of different companies where we have multiple GPs invested along side of us or even leading the transaction where we’re an investor. And there is almost always a range of valuations, particularly over the past five years, and every year it’s less and less situations where two or three general partners valued that asset. Even though they own the exact same security their valuations differ. It might differ by a few pennies on the dollar, but we’ve seen valuation differences as big as 50 cents.

Lambrech: What do you do in that situation typically when you see such a large gap between two GPs?

Friedman: Well, what we do is we’ll do our own valuation methodology. We’ll come up with what we think the valuation is based on the best available information. But then we’ll also go and discuss with those GPs what valuation methodologies we’re using. Again it’s going to depend on the relationship and where we stand in the company, but it might be that one of them just saying we’re just using comparable companies that’s going to come out lower in almost all cases. The other one says we’re relying much more heavily on discounted cash flow where when you’re going up with the forecasts and if you really believe the company is going to grow at a rapid pace that will lead to a higher valuation. So when we work with our auditors we have to on those situations we have to even go a level farther and really show our work, how we’re coming up with it when there is such a divergence. Cause most of the time the auditors will say well where do other people mark, and if there is a big divergence they’re actually going to dig in a lot more on those cases.

Vannucci: And I guess one other point to throw out there we talk about control or minority, well what does that really mean? Does that mean if you’re a private equity group and have multiple funds do you look at control as being defined greater than 51% across all funds? And then on the flip side do you look at control or minority if you’re involved in club deals? So those are other things that are being talked about right now at the IACPA level, different white papers out there. What does that really mean, is it control or is it minority? Which is going to drive how you should value a company.

Snow: Well how about in a situation where a private equity firm or venture capital firm might move from a minority position to a majority position, or the other way along the lifespan of an investment? What kind of complexities does that bring up and how do people solve them?

Lambrech: Well I’ll start. I think a big part of the, the control issue is obviously as the word implies how much can you dictate the outcome of the company? How  much  influence  do  you  have  over  management really to sell a company now versus make a strategic change in the business and grow it over several years? I’ve heard a lot of the minority investors talk about well we’re on the board and, and we sort of exert our influence, we control our own destiny. But the reality of it is, is that unless you have the perfect alignment amongst all those minority investors that are going to push this company in the same direction you’re probably not going to have that much influence on really what the outcome is. I’m not suggesting you’re just along for the ride, but the influence that you have is less than if you, you control the company, you control the stock. In those cases you may have more than one board seat, so your level of influence on the company is much greater when you have a control position.

Friedman: And, and in those cases cause we’ve, we’ve encountered those just, just recently one of the companies we’re involved with where there is very different opinions on what value the company is. And, and more importantly to your point earlier is at what value do people want to sell their, their investment? So some people might want to sell it at, at a price down here and other people say well I’m not going to sell unless the price is up here. And those differences do create some tensions in the company and then around the board table, most of the time healthy tension. But it makes it harder to put an accounting value on every quarter.

Vannucci: And just from the auditor’s standpoint is it ultimately comes back under formally 157 and it’s now ASC 820, it’s market participants. So from, as we audit a company I don’t care what someone wants to sell it for, what they bought it for, it is what the value is today and it’s market participant. John you spoke of synergies or,  or strategic sales and ultimately you can’t look at synergies or strategic sales unless it would be deemed market participant point of view. And it always comes back to that market participant point of view.

Lambrech: But market participants vary.

Vannucci: They do.

Lambrech: Vary, yes. They don’t always look at things the same way. You could have, you know, very bright institutional investors that you know, just fundamentally look at a company differently and it doesn’t necessarily mean that one is right or one is wrong. So I always stumbled a little bit on the market participants cause it kind of assumes that everybody sort of, thinks of things more or less the same way and that’s not always the case.

Vannucci: And that’s a good point if you use a GPC method typically you’re looking at a strategic buyer versus now a lot of portfolio companies as it finally matures another buyer could be another fund.

Lambrech: Another financial sponsor.

Vannucci: It’s strategic versus finance, and then you tell me if it’s finance and then you’re looking at what a fund is willing to pay under market participants. That’s a lot different, and that’s a lot harder to grasp than necessarily using a GPC method which is probably more strategic so.

Lambrech: That’s right.

Friedman: I would just add -­‐ under any of the methodologies there is always going to be these, these differences and even just you know, comparable companies going back on the minority investments, you know, we’ll look at what market comparables are out there. And many firms for the same investment will use different market comparables, and at the end of the day there are no two companies that are exactly alike. Even if you’re selling a commodity product there are no two companies that are exactly alike. They’re always going to have their individual nuances, which should affect valuation up or down. Which is very hard to capture in a single or even multiple methodologies.

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