Business values: how public and private company markets differ

Most people are familiar with the public stock market. The players are buyers and sellers who are individuals, mutual funds, and financial institutions. Most trades of public company stock are so-called minority ownership transfers.  In other words, they involve a small portion of a company’s stock pool.

The public stock market is highly liquid, investments are held for a relatively short time. Moreover, investor risk tolerance tends to be robust as the markets are very efficient and unloading unwanted investment is quick and low cost. Importantly, you can easily finance investments through banks and brokers at lower short term interest rates. Investors tend to be passive and look to diversify their risk by building a broad based investment portfolio.

The situation looks very different in the private company investment market. This is where the ownership interests in whole companies change hands. Buyers and sellers strike high stakes bargains for controlling ownership interest. The players in this market are often professional investors, corporate M&A teams, and private equity investment shops.

You face higher risks of making a bad judgment call. So short term risk tolerance is lower than in the public stock market. Business sales are financed by the market participants themselves through cash and stock deals as well as investment banks using long-term financing. Given the higher risks and complex deal structures, private company investors tend to take an active role in the companies they buy.

Be careful when applying control premiums derived from the public stock market, such as tender offers, to private company valuations. If a guideline public company’s stock trades at market prices way above the intrinsic value of the firm, the public business value is potentially misleading.

See Valuation Tour