Opening a company to external investment can increase its value by 6.5%, new research from Vlerick Business School has found.
Dr. Johan Van den Cruijce, Postdoctoral Research Fellow at Vlerick, researched the effect that engaging with external investment can have on a business, particularly when considering the universally applied private company discount.
Common industry practice when evaluating a private company, whether it is open or close to external investment, is to apply a 20-40% reduction to the total value of a business.
But this private company discount is frequently miscalculated, often mistaking the differences of liquidity between private and public companies as a sole determining factor. Liquidity matters, yes, but private companies also tend to be smaller and less transparent with a different diversification of their assets, says Van den Cruijce. All of these elements can impact the private company discount. If a private company is open to external investment, its value is higher by 6.5% compared to companies that are effectively closed to third parties.
Significantly, the research also highlights that the discount can be partially controlled, notably by providing an exit possibility to shareholders. Such exit possibility can take a variety of forms and can increase a company’s value by almost 10%.
Previous investigations have failed to produce such results due not including as detailed contextual information within their data sources. Dr. Van den Cruijce, formally trained as a lawyer, knew where this could be obtained: in court decisions that decide on the valuation of private companies.
“This method uses both qualitative and quantitative techniques to test which elements have an impact on the private company discount decided by courts” remarks Van den Cruijce.
“When we look at how judges motivate decisions on a private company discount, based on a company’s position, assets, rights and obligations etc., we can identify and test the impact of elements that cannot be found in more commonly used sources that are based on financial and transactional data.””
The research highlights the need to rethink the private company discount, which too often is engaged without full or correct information. Instead, as highlighted, the private company discount can be determined to a much more accurate degree with the company able to partially control its value. Applying data sourced from court decisions creates a much more encompassing understanding of how certain factors impact a business’ value.
Johan Van den Cruijce is the first candidate to successfully defend his thesis in the joint Doctorate of Business Administration (DBA) programme between Vlerick Business School, KU Leuven, and Ghent University. Unlike others, the joint programme is a research-led PhD also, differentiating it from other DBAs.