Evaluating privately held shares

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
bwalling
Posts: 60
Joined: Thu Nov 25, 2010 1:04 pm

Evaluating privately held shares

Post by bwalling » Sun Dec 01, 2019 2:05 pm

Due to an inheritance, we are receiving a significant portion of shares in a privately held bank. They pay dividends, as well as distributions to cover taxes on the bank's profit. The dividends are significant (six figures per year), and there is a one time offer to buy the shares back due to the death/transfer. They'd be purchased at around 20-25x the annual dividend. From what I've seen, the shares have appreciated ~10% per year for several decades, aside from the dividend.

It's a return that can't be replicated in the public market, but holding it would significantly alter diversification (the value the shares would be bought back puts the bank stock at about 70% of our invested assets). One option is to invest the dividends in index funds and slowly diversify with the combination of that and our regular savings. I'm inclined to split the difference and sell half of the bank stock back to the bank, investing the proceeds, and then investing the dividends as they come.

bogglizer
Posts: 213
Joined: Tue Aug 16, 2016 8:56 pm

Re: Evaluating privately held shares

Post by bogglizer » Sun Dec 01, 2019 2:59 pm

I am not convinced that the standard diversification arguments apply to privately held equity. Some of the assumptions break down.

HomeStretch
Posts: 2968
Joined: Thu Dec 27, 2018 3:06 pm

Re: Evaluating privately held shares

Post by HomeStretch » Sun Dec 01, 2019 3:04 pm

Are audited financial and other information available to you to make an informed decision whether to hold even some of the stock?

Agree with selling some (or all) to diversify.
Last edited by HomeStretch on Sun Dec 01, 2019 3:34 pm, edited 1 time in total.

User avatar
David Jay
Posts: 7311
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Evaluating privately held shares

Post by David Jay » Sun Dec 01, 2019 3:08 pm

Il-liquid holdings are a real challenge to evaluate and price. I would evaluate the holding as a revenue stream but not as a capital asset - that is, they generate cash flow but you can’t sell them at will. So share value (and share value appreciation) should be ignored.

Look at the revenue stream and calculate the value of the revenue stream. If it is unclear whether to hold or sell on the basis of the revenue stream then I like your approach of splitting the difference.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

Chuck5781
Posts: 54
Joined: Mon Sep 19, 2016 8:07 pm

Re: Evaluating privately held shares

Post by Chuck5781 » Sun Dec 01, 2019 3:31 pm

Not certain about this particular case, but bank stocks can be held in the bank directly, or in a bank holding company who in turn owns or controls the bank. It would be good to know the difference.

Privately held banks are typically valued based on Tangible Book Value. You should ask the appropriate people at the bank what that is, and what multiple of that is being offered for the shares. You will want to know the tangible book of the organization you hold stock in - either the bank or its holding company.

Any value below 100% of tangible book of a healthy bank would be unacceptable to me.

If you have any other information you can provide, please do so. Important to know would be Return on Average Assets and Return on Equity. Based on the fact you are receiving a dividend intended to pay taxes, this is likely an s-Corp where taxes are not paid by the bank, rather by the shareholders individually, avoiding double taxation. This results in an extraordinarily large Return on Equity number, for comparison purposes.

Data on all banks is available online at the FDIC website, but an audited financial from the bank would be easier to evaluate.

User avatar
RickBoglehead
Posts: 5021
Joined: Wed Feb 14, 2018 9:10 am
Location: In a house

Re: Evaluating privately held shares

Post by RickBoglehead » Sun Dec 01, 2019 3:46 pm

To me, it depends. Without this inheritance, how do things stand? If these funds aren't needed to meet your retirement goals, and taking the dividends alone would be enough, then a 10% appreciation per year is quite nice.
Avid user of forums on variety of interests-financial, home brewing, F-150, PHEV, home repair, etc. Enjoy learning & passing on knowledge. It's PRINCIPAL, not PRINCIPLE. I ADVISE you to seek ADVICE.

bsteiner
Posts: 4414
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Evaluating privately held shares

Post by bsteiner » Sun Dec 01, 2019 3:58 pm

Will the executors share the estate tax appraisal that they obtained? Was it from a reputable appraisal firm?

There are people who are knowledgeable in valuing bank shares. You might try to find one of them and have him/her value the shares.

An appraiser should be able to give you a sense of what the shares would be worth if they were publicly traded, and the risk of the bank failing.

You may want to try to get a sense of the extent to which other shareholders might be willing to buy shares, and at what price.

You may want to try to get a sense of the likelihood the bank might sell out, or go public.

Another factor in your decision may be whether you have sufficient other assets without these shares, or whether you expect to need the proceeds of these shares.

Is the bank an S corporation so that you have to pay tax on the undistributed income, or is it a C corporation so you only pay tax on the dividends?

Chuck5781
Posts: 54
Joined: Mon Sep 19, 2016 8:07 pm

Re: Evaluating privately held shares

Post by Chuck5781 » Sun Dec 01, 2019 4:01 pm

RickBoglehead wrote:
Sun Dec 01, 2019 3:46 pm
To me, it depends. Without this inheritance, how do things stand? If these funds aren't needed to meet your retirement goals, and taking the dividends alone would be enough, then a 10% appreciation per year is quite nice.

True , all of this. I have some myself and it’s hopefully going to my heirs.

The fact to validate would be the base value used to determine the annual appreciation. 10% appreciation of a fair value is very different from 10% of a valuation that understates the true value by half.

Private banks have been known to under value their stock during these types of repurchase transactions, because of the unique nature of their valuation. A good starting point for the conversation is Book Value, then start the return and appreciation math from there.
The richest man is not he who has the most, but he who needs the least.

User avatar
Stinky
Posts: 2479
Joined: Mon Jun 12, 2017 11:38 am
Location: Sweet Home Alabama

Re: Evaluating privately held shares

Post by Stinky » Sun Dec 01, 2019 4:16 pm

If you don't take advantage of this repurchase option now, how could you dispose of the shares in the future?

Would the bank repurchase them, and if so, at what price? If not, would you need to find a willing party to buy them from you?
It's a GREAT day to be alive - Travis Tritt

Topic Author
bwalling
Posts: 60
Joined: Thu Nov 25, 2010 1:04 pm

Re: Evaluating privately held shares

Post by bwalling » Sun Dec 01, 2019 4:57 pm

Chuck5781 wrote:
Sun Dec 01, 2019 3:31 pm
Any value below 100% of tangible book of a healthy bank would be unacceptable to me.
The offer is at 1.5x book.
If you have any other information you can provide, please do so. Important to know would be Return on Average Assets and Return on Equity. Based on the fact you are receiving a dividend intended to pay taxes, this is likely an s-Corp where taxes are not paid by the bank, rather by the shareholders individually, avoiding double taxation. This results in an extraordinarily large Return on Equity number, for comparison purposes.
The dividends and distributions are separate. Distributions are to cover personal income taxes related to the bank, which is an S-Corp.
Stinky wrote:
Sun Dec 01, 2019 4:16 pm
If you don't take advantage of this repurchase option now, how could you dispose of the shares in the future?

Would the bank repurchase them, and if so, at what price? If not, would you need to find a willing party to buy them from you?
Only to another shareholder or back to the bank, who does periodically buy back. They are not interested in more shareholders, so selling to an outside party is not an option.
RickBoglehead wrote:
Sun Dec 01, 2019 3:46 pm
To me, it depends. Without this inheritance, how do things stand? If these funds aren't needed to meet your retirement goals, and taking the dividends alone would be enough, then a 10% appreciation per year is quite nice.
I'll be able to retire at 60 without the bank stock, assuming things go according to plan (no major period of not working, no major adverse events, etc).
bsteiner wrote:
Sun Dec 01, 2019 3:58 pm
You may want to try to get a sense of the likelihood the bank might sell out, or go public.
I will hopefully have more information this week. Lawyers have been slow on this part of the estate. I have publicly available information (banks all report quarterly information, regardless of public or private, and I have the information that's out in the news about them (growth plans, etc). Hopefully, I'll have some level of investor communications this week.
Is the bank an S corporation so that you have to pay tax on the undistributed income, or is it a C corporation so you only pay tax on the dividends?
It is an S Corp, which is why they have shareholder distributions to cover income taxes (separate from the dividends).

Chuck5781
Posts: 54
Joined: Mon Sep 19, 2016 8:07 pm

Re: Evaluating privately held shares

Post by Chuck5781 » Sun Dec 01, 2019 10:20 pm

As a general rule of thumb, 1.5x Book paid in cash would be a more than fair price for a minority interest in illiquid privately held bank stock.

Given that, I would defer to all the comments here about the percent of your portfolio this represents, your risk tolerance, your need for liquidity, etc.

But I wouldn’t be concerned that the buyers were unfairly taking advantage of me.
Last edited by Chuck5781 on Sun Dec 01, 2019 10:24 pm, edited 1 time in total.
The richest man is not he who has the most, but he who needs the least.

MotoTrojan
Posts: 6907
Joined: Wed Feb 01, 2017 8:39 pm

Re: Evaluating privately held shares

Post by MotoTrojan » Sun Dec 01, 2019 10:23 pm

There are plenty of stocks that have returned 14% for decades, and are totally liquid and transparent public companies. Sell it all, there is no reason to believe this is a better bet than those other companies.

I am not suggesting you actually but any of those other public companies.

User avatar
Stinky
Posts: 2479
Joined: Mon Jun 12, 2017 11:38 am
Location: Sweet Home Alabama

Re: Evaluating privately held shares

Post by Stinky » Sun Dec 01, 2019 10:29 pm

bwalling wrote:
Sun Dec 01, 2019 4:57 pm
Stinky wrote:
Sun Dec 01, 2019 4:16 pm
If you don't take advantage of this repurchase option now, how could you dispose of the shares in the future?

Would the bank repurchase them, and if so, at what price? If not, would you need to find a willing party to buy them from you?
Only to another shareholder or back to the bank, who does periodically buy back. They are not interested in more shareholders, so selling to an outside party is not an option.
Having illiquid stock in an amount that is material to my net worth would really concern me. Especially when the pool of potential buyers is severely limited.

OP, your initial indication (I think) was to cash in half and keep the other half. Keeping half is the absolute maximum that I would do. Personally, I would cash in the whole thing and reinvest elsewhere.
It's a GREAT day to be alive - Travis Tritt

User avatar
alec
Posts: 3038
Joined: Fri Mar 02, 2007 2:15 pm

Re: Evaluating privately held shares

Post by alec » Sun Dec 01, 2019 10:42 pm

I think I’d take a step back and think about whether, instead of owning the stock, you just inherited cash. Would you take all that cash and go buy however much worth of stock of this private bank?

If no, then I’d sell all the stock in the private bank and invest the cash according to your IPS.
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" - Upton Sinclair

User avatar
David Jay
Posts: 7311
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Evaluating privately held shares

Post by David Jay » Sun Dec 01, 2019 11:15 pm

alec wrote:
Sun Dec 01, 2019 10:42 pm
I think I’d take a step back and think about whether, instead of owning the stock, you just inherited cash. Would you take all that cash and go buy however much worth of stock of this private bank?
I always see that response and think: “I’ve got to remember that test”. But I forget until I see someone post it again. It really is a great way to address anchoring behavior.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

123
Posts: 5220
Joined: Fri Oct 12, 2012 3:55 pm

Re: Evaluating privately held shares

Post by 123 » Sun Dec 01, 2019 11:34 pm

Based on what I observed about a privately held bank in a local community over a period of years I would encourage you to sell. The bank got its start-up capital from a small group of local investors, a number of them physicians. The largest investors were on the board of directors and knew the group that was to operate the bank. The bank did well for many years and paid excellent dividends to investors. However over time (20 years +) many of the initial investors passed away and share ownership became more diversified. Those that ran the bank retired over the years and a new management team came in for day-to-day operations. In the interests of maintaining the dividend and "looking good" the bank weakened their loan portfolio with a bunch of risky business loans that were highly concentrated among a small number of borrowers. Not surprisingly the bankruptcy of a couple of customers caused the bank to go belly-up as well.

So the privately held bank was initially run by a very focused group who had their "own skin" in the game, so they paid attention. Over time the investors cared less and less about the bank, after all the money they had in the bank was not money they had earned themselves but inherited funds they got as a gift.

The best of businesses can succumb to mediocrity over time. Get out while you can and diversify.
The closest helping hand is at the end of your own arm.

Chuck5781
Posts: 54
Joined: Mon Sep 19, 2016 8:07 pm

Re: Evaluating privately held shares

Post by Chuck5781 » Mon Dec 02, 2019 7:17 am

123 wrote:
Sun Dec 01, 2019 11:34 pm
Based on what I observed about a privately held bank in a local community over a period of years I would encourage you to sell. The bank got its start-up capital from a small group of local investors, a number of them physicians. The largest investors were on the board of directors and knew the group that was to operate the bank.

The best of businesses can succumb to mediocrity over time. Get out while you can and diversify.

My experience is these investments are appropriate for two types of investors, described above. One, professionals flush with cash, busy with their careers, who can be very patient and make wealth thru long term gains. The other, businessmen who are active in the community, are a great source of lead referrals for the bank, and also very knowledgeable about the credit worthiness of the borrowers and the practicality of their business ventures.


I think having such a large percentage of your net worth in a single investment is a bad idea, and having it in an illiquid closely held firm makes it even worse.

My advice is take the 1.5 times book offer, and move on.

not4me
Posts: 699
Joined: Thu May 25, 2017 3:08 pm

Re: Evaluating privately held shares

Post by not4me » Mon Dec 02, 2019 1:12 pm

Several of my considerations have already been mentioned, but will add a couple. It sounds to me that you are likely getting a fair price -- I'd somewhat assume there are legalities at work in which some of the main players are making sure they'll get treated fairly when it is their turn. I'd try & give some thought to the near term future. Management is a key factor (as pointed out earlier), but so is the "environment". Is bank a state chartered only bank? Reliant on a specific geographic area and/or industry for most profit? Etc. Are there share classes above you in the capital structure that might get taken care of 1st if things went bad?

What about your estate/disability plans....are those who would deal with this asset in those cases be able to? want to?

You may not want to go into detail regarding how this came to you, but is part of your consideration an emotional attachment (respecting wishes...)?

Personally, I think I would strongly consider selling part & invest dividends of the part I kept.

Post Reply