Deconstructing Private Equity Buyout Valuations

Abstract

Private equity grows from strength-to-strength, with 2021 being a record year for private equity buyouts. The success of private equity is dependent upon making large returns on investment. Partly, success is derived from growing acquired companies, making acquired companies more efficient, and through the use of substantial leverage. However, it is also critical not to overpay for targets. Accordingly, the manner in which private equity firms value potential targets is crucial. The most common valuation method is “discounted cash-flow” (DCF). For those without finance backgrounds, however, DCF valuation methodology can appear intimidatingly complex. In this article, DCF is deconstructed and simplified to enable practitioners without finance backgrounds, such as lawyers, and any students of the field to more easily understand the fundamentals of the concept. For an M&A lawyer, a deeper understanding of how companies are valued can be an important aid to providing effective advice to private equity clients.

Keywords: Private Equity, Mergers and Acquisitions, M&A, Valuations, Discounted Cash Flow, Buyouts

JEL Classification: G11, G12, G34, K20, M21, M41