What unique risks and opportunities exist in a public-to-private deal when valuing a target, and how should you model the equity risk premium?

• A. Risks include delisting, liquidity constraints, and market mispricing; opportunities include operational improvements and financial arbitrage; model ERP by adjusting discount rates for control and liquidity discounts
• B. There are no unique risks; treat as private
• C. ERP should be zero
• D. Only tax considerations matter

Answer: (A)

In a public-to-private deal, you have to account for two sides of value: risks and value-creation opportunities that arise when a public company is taken private. Delisting removes continuous public pricing and coverage, liquidity for the equity becomes constrained, and there can be mispricing in the public market that you might leverage, all of which change the risk profile versus a typical public investment. At the same time, going private creates opportunities to drive value through operational improvements, strategic changes, and optimized capital structure without the constraints of public markets.

When modeling the equity risk premium in this context, you don’t rely on the same public-market ERP as for a freely traded equity. Instead, you embed the added private-ownership risks into the valuation by adjusting the discount rate to reflect control and liquidity factors. This typically means using a higher cost of equity (or a higher overall discount rate) in the cash flow valuation to capture the greater risk and illiquidity, with the deal price often incorporating a control premium. The other options overlook these distinctive risks and the need to tailor the risk adjustment for a going-private transaction.