Alternative Investment Valuation

CFA Level 1 - Alternative Investments

Alternative investment products are generally run by firms whose ownership is controlled by only a handful of owners. However, while most closely-held companies are small, non-public firms, some large publicly-traded companies fall into this category if their stock is held by only a few institutional owners. Closely-held companies can be organized in various forms such as general or limited partnership, sole proprietorship, regular corporation etc. The legal environment in which a closely-held company operates impacts the valuation of that company. Prevailing state laws, for example, define company ownership, voting power and other issues of control. Furthermore, asset valuation may depend on interpretations specific to the company's legal jurisdiction. 

Alternative Valuation Methods for Closely Held Companies

• Cost Approach - The cost approach determines what it would cost to replace all the company's assets in their present form and condition. 
• Comparables Approach - Market values are estimated via some benchmark. The benchmark may be a similar corporation that is publicly-traded or has recently sold. The benchmark needs to be constantly updated to reflect market changes.
• Income Approach - Uses a discounted income or cash flow model. Any anticipated future economic income flows are discounted at an appropriate rate.
  • After valuing the firm, a number of discounts or premiums are applied to the preliminary value.
  • Discounts usually are taken for the illiquidity. Since the stock of closely-held or private corporations does not trade on public markets and may be difficult to sell, a significant discount is applied.   
  • A discount may also apply if one is only acquiring a minority interest and will have little influence in how the business is run.
  • Alternatively, a premium may be paid for acquiring controlling interest. 

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