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June 2 June 2 June 2 June 2 –––– 5, 2010 5, 2010 5, 2010 5, 2010 Miami, FL USA Miami, FL USA Miami, FL USA Miami, FL USA

IBA Symposium presents

Discount Lack of Marketability: Discount Lack of Marketability: Discount Lack of Marketability: Discount Lack of Marketability: A Case Study Approach to A Case Study Approach to A Case Study Approach to A Case Study Approach to

Understanding Supporting MethodologyUnderstanding Supporting MethodologyUnderstanding Supporting MethodologyUnderstanding Supporting Methodology

James Lurie & Kevin Yeanoplos

NACVA and the IBA 2010 Annual ConsultantsNACVA and the IBA 2010 Annual ConsultantsNACVA and the IBA 2010 Annual ConsultantsNACVA and the IBA 2010 Annual Consultants’’’’ ConferenceConferenceConferenceConference

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IBA Symposium presents

Discount Lack of MarketabilityDiscount Lack of MarketabilityDiscount Lack of MarketabilityDiscount Lack of Marketability

James Lurie

Kevin Yeanoplos

Acknowledgement

We gratefully acknowledge the invaluable contributions of the following individual for graciously allowing us to either directly or indirectly utilize certain of their PowerPoint slides as a basis for this presentation:

James Hitchner, CPA/ABV, ASA,

President of Valuation Products and Services

Slides 5-25, 28-35

Case Study Facts

� Surv Yu, CPA/ABV, ASA, CBA, CVA is the appraiser retained by Sue Freeley, Esq. to review the work of another appraiser, Les Vallew

� Freeley hired Vallew to prepare a gift tax valuation and is worried about whether Vallew can support his selected discount for lack of marketability of 70%

� Freeley is fine with Vallew’s pre-DLOM value of $40 million or $4,000 per share and thinks it is an objective and unbiased minority interest value that has solid support

� Freeley thinks the DLOM should be around 30%

� The name of the company is Studs R'Us (SRU)

� SRU is a C corp

Case Study Facts

� SRU operates men’s apparel retail stores in six Northeastern states

� It has 75 stores and plans to open four stores a year for the next five years

� SRU employs about 1,700 people

� Retail men’s clothing is highly competitive

� The company started in 1962 and was founded by brothers Larry, Moe and Curley Pop

– Each originally had a 1/3 interest and each family currently owns 1/3

� Each brother had previously made small gifts to their children

� The brothers are 68, 70 and 74 years of age

Case Study Facts

� The Pop family has no plans to sell, go public or offer ownership outside the company

� Curley Pop Jr., son of Curley Pop Sr., is the current CEO and President of Studs R'Us

– He is in good health and is 52 years old

� One class of common stock

� One prior 3% redemption of stock in 2000; one of the brothers needed the money at that time

� The valuation date is August 1, 2009

� There are 10,000 shares of common stock outstanding

� The size of the block of stock to be gifted is 800 shares (8%) to a first-time shareholder daughter

Case Study Facts

� The daughter is 38 years old and in good health

� The three senior founders each currently owns 24% before the 8% gift

� The remaining 28% is owned by four sons and daughters at 7% each

� The relationship among the three founding brothers is cordial

� There are no non-compete agreements

� There is not a key person situation and management has depth at the top levels

� There is no serious litigation

Case Study Facts

� There are no restrictions on stock transfers in any loan agreements

� State law requires greater than 50% for control and does not allow discounts in fair value situations

� All shareholders currently have a harmonious relationship

� There have been three potential buyers who have expressed an interest in buying the company in the last two years, but the owners do not want to sell and have not gone beyond initial conversations

� The three main stockholders are wealthy and have other liquid investments

Case Study Facts

� The management team is considered very competent

� The Company’s interest bearing debt at 7/1/09 is $10 million

� Fiscal year end is July 31, 2009

� The company has had unqualified audited financial statements for the past five years

Case Study Facts

Five year FYE financial information ($000)

After Tax Total Book

Revenue EBITDA Income Assets Value

2009 118 10.9 4.2 57 31

2008 112 9.3 3.6 51 27

2007 100 10.0 4.4 43 23

2006 72 6.9 3.0 31 20

2005 62 6.8 3.4 24 17

Case Study Facts

� SRU has strong capitalization and access to bank debt

� SRU has a strong current ratio at the valuation date

� Asset turnover ratio for 2009 (revenue/total assets) is very good

� SRU has adequate cash for operations and expansion (with bank debt)

� SRU is widely known as a good retailer in the industry

� Tax rate approximates 40%

� Net income margin for 2009 is 3.6%

� The company has not paid any dividends for the past five years and only paid nominal dividends prior to that

Case Study Facts

� The Company has no plans to pay dividends in the near future

� The company uses bank debt and retained earnings for expansion and growth

� SRU was not a leader in its industry but it was diversified within its sector of the industry and was very profitable

� Its future was bright at the valuation date

� There is no one controlling shareholder

� There was a shareholder agreement giving the company and the other shareholders the right of first refusal before a sale to outsiders

Case Study Facts

� The intent of the shareholder agreement was to preserve family ownership and control

� There was no formula or value in the shareholder agreement

� The shareholder agreement is considered legally binding

� There is no known future liquidity event and the holding period for the gifted 8% interest is unknown

16

�Compare the price of a company’s restricted stock to

an otherwise identical share of that company’s

publicly-traded stock

Restricted Stock Studies - Methodology

Studies of Restricted Securities Transactions Summary

Study Period of Study Discount for Lackof Marketability

Securities Exchange Comm. 1966-1969 26%

Hall & Polacek 1979-1992 23%

Silber 1981-1988 33.75%

Stryker & Pollack 1978-1982 45%

Maher 1969-1970 35%

Gelman 1968-1970 33%

Moroney 1969-1973 (1) 35.5%

Trout 1968-1972 33.45%

(1) Did not state exact time, but within this time frame

Studies of Restricted Securities Transactions Summary

(continued)

Study Period of Study Discount for Lackof Marketability

Willamette 1981-1984 31.2%

Mgt. Planning Inc. 1980-1995 28%

FMV Opinions, Inc. 1979-1992 23%

Johnson 1991-1995 20%

Columbia Financial Gr. 1996-1997 21%

Columbia Financial Gr. * 1997-1998 13%

* One-year holding period

� Restricted Stock Study Results by SIC Code

Range:

1000s 2000s 3000s 4000s 5000s 6000s 7000s 8000s

No. Transactions:

14 32 78 22 16 25 25 30

Average Discount:

21.60% 23.40% 24.50% 21.00% 12.00% 16.90% 24.20% 23.00%

Median Discount:

18.50% 19.40% 24.00% 15.40% 12.50% 13.40% 23.70% 25.60%

Standard Deviation:

15.10% 15.10% 17.10% 14.20% 7.60% 15.10% 15.60% 18.70%

FMV Opinions Study - (1980 – 1997)

Effect Study

Volatility Factors

Stability Price stability Inverse MP FMV Bajaj Earning stability Inverse MP Revenue stability Inverse MP Financial distress Direct Bajaj

Size Revenue Inverse MP SEC/IIS FMV Silber Level of earnings Inverse MP SEC/IIS FMV Silber Market price per share/market cap Inverse MP FMV Assets Inverse FMV

Liquidity/holding period

Block size to shares outstanding Direct MP FMV Silber Bajaj Dollar – trading volume Inverse MP

MP = Management Planning, Inc. SEC/IIS = SEC/Institutional Investor Study FMV = FMV Opinions, Inc. Silber = William Silber Bajaj = Mukesh Bajaj, et al.

20

Qualitative DLOM Support - Restricted Stock Factors

21

� Volatility factors

– The more uncertain the asset’s value, the higher the DLOM

– The more difficult it is for outsiders to appraise the value of an asset, the greater

the DLOM

� Holding period

– If there are close substitutes for the assets, the lower the DLOM (public stock v.

fine art)

– The greater the duration of restrictions on trading, the larger the DLOM

– The larger the block of stock to be sold, the greater the DLOM

– DLOM vs. due diligence and monitoring

Qualitative DLOM Support - Dr. Mukesh Bajaj Factors

� Firm-specific and issue-specific (size) factors influence the size of the discount (wide dispersion of discounts)

� DLOMs, like discount rates, vary over time, so old studies are less relevant

� Purchasers of restricted stock may be service providers who receive discounted prices

� Due diligence and monitoring costs are significant components of DLOM

� A “zero cost collar” (buy put, sell call, borrow against security) would eliminate the need for DLOM

� A few studies (Silber, Hertzel & Smith, Trout, Bajaj) ran regression analyses and R2 was not high (approx. 30%); key variables such as holding period and transfer restrictions were omitted

Criticism of Restricted Stock Studies

22

� Accessibility and reliability of financial information

� Number of shareholders

� Concentration of control owners

� Number of potential buyers

� Access to capital marketplace

� Size of the business

� Volume of comparable private transactions

� Owners with adversarial relationships or an inconsistent business philosophy

� Desirability of the business

� Existence of restricted stock agreements

Qualitative Factors for Benchmarking

� Existence of non-compete agreements

� Yield

� Liquidity of control owners

� The existence of other liquid assets on the part of the owners may reduce the desire or need to transfer the business

� Quality and competence of management team

� Existence and effect of pending litigation

� Size of block of stock

� Existence and extent of contractual restrictions

� Degree and effect of industry regulations


� Effects of state law

� Existence of swing vote attributes

� Relationship between controlling and non-controlling shareholders


Benchmarking ExampleImpact on Marketability Discount

Warrants anABOVE average

Discount

Warrants anAVERAGEDiscount

Warrants anBELOW average

Discount

Marketability Adjustment Factors

STARTING POINT 35% 35% 35%

History and Outlook

Financial Factors

Management

Holding Period

Redemption Policy

Transfer of Control

Restrictions on Transfer

Cash Distribution Policy

Information Access and Reliability

Cost of Public Offering

Other Factor 1

Other Factor 2

Other Factor 3, etc.

+

+

+

+

+

+

+

+

+

+

+

+

+

-

-

-

-

-

-

-

-

-

-

-

-

-

No Change

ENDING POINT >35% 35% <35%

Comparison of Attributes to Restricted Stock Studies

Common Attributes of Restricted Securities Positive Negative Neutral

Piggyback option to register stock with next registration statement X

Option to require registration at seller's expense X

Option to require registration at buyer's expense X

Right to receive continuous disclosure of information X

Right to select one or more directors X

Option to purchase additional shares of issuer's stock X

Provision giving the buyer the right to a greater voice in operations X

Approximately 1 year until marketability X

Underlying company is already public X

Audited financial statements X

Note: This chart compares the attributes of the Company to restricted securities. Each attribute is rated positive, negative, or neutral,

depending on whether the respective attribute for the Company's stock is superior, inferior, or the same as representative restricted securities.

Comparison of Attributes to Restricted Securities

� Advantages

� Easy application

� Shows consideration of relevant characteristics

� Disadvantages

� Highly judgmental

� Not tied directly to transactions

� Courts indicate preference for other methods

Benchmark Approach

29

� Identify and compare the price paid for a closely-held share of a company’s common stock (or an option thereon) with the price at which “identical” stock was subsequently sold in an initial public offering (IPO)

Pre-IPO Studies - Methodology

Summary of Emory Pre-IPO Studies

Period of Study Number of Mean Disc. Median Disc.Transactions

May 1997–December 2000 (a) 28 50% 52%

May 1997–December 2000 (b) 36 48% 44%

May 1997–March 2000 (c) 53 54% 54%

November 1995–April 1997 91 43% 42%

January 1994–June 1995 46 45% 45%

February 1992–July 1993 54 45% 44%

(a) Expanded study (b) Limited study (c) Dot.com study

Summary of Emory Studies (continued)

Period of Study Number of Mean Disc. Median Disc.Transactions

August 1990–January 1992 35 42% 40%

February 1989–July 1990 23 45% 40%

August 1987–January 1989 27 45% 45%

January 1985–June 1986 21 43% 43%

January 1980–June 1981 21 60% 66%

Combined Results (d) 13 47% 48%

(d) To avoid double counting, transactions from the Dot.Com and Limited study are included only as a part of the Expanded study

� Fifth Month

– The mean and median discounts on the 47 transactions taking place in the fifth

month prior to the IPOs were 54 and 50 percent

� Fourth Month

– The mean and median discounts on the 43 transactions that took place in the

fourth month prior to the IPOs were both 51 percent

� Third Month

– The mean and median discounts on the 56 transactions taking place in the third

month prior to the initial public offerings were 43 and 42 percent

Hitchner/Morris Study No. 1 - (January 1980 – June 1995)

Pre-IPO Studies - Observations and Criticism

33

� Implied discounts are implausibly large

– 45% discount, 6-month restriction = 213% annualized return

– Buyers of pre-IPO shares are likely insiders who receive discounted prices forservices rendered

– Sample selection problem – by focusing only on winners, you overstate the discount, as probability of failure is excluded from analysis

– Other factors, both exogenous and endogenous, may affect change in value

� Time lag between measurement dates

� Changes in interest rates, market risk premiums, market sentiments, etc.

� Benchmarks achieved, relationships established, etc.

� Willamette controls for change in market P/E multiples

� Due to the presence of these factors, less weight should be placed on the pre-IPO studies in estimating the lack of marketability discount.

Valuation Advisors’ DLOM Database

� Transactions from 1985 to the present

– 3,957 database elements

– 285 SIC Codes

– Median revenue $25.9 million

– Sortable by SIC/NAICS and:

� Revenues

� Assets

� Operating income

� Time period (year)

� Common stock, common stock options or convertible preferred stock

Valuation Advisors’ DLOM Database

�Strengths:

– Database size

– Ease of use

�Weaknesses:

– General problems with pre-IPO data as highlighted by Dr. Bajaj

� Discounts may reflect elements of compensation.

� Changes in prospects between pre-IPO issuance and IPO, with studies including only those achieving operating success between issuance and IPO.

– Differences in market and individual stock volatilities over time

– Variability in time spans between pre-IPO issuance and IPO (up to 2 years prior to IPO)

– Results include securities other than common stock (convertible preferred and options).

� Five key inputs:

– Marketable minority value of the stock

– Expected growth rate of a marketable minority shareholder interest

– Expected holding period

– Required rate of return for a nonmarketable minority interest

– Expected dividend payments

Quantitative Marketability Discount Model (QMDM)

QMDM

Studs R'Us

Quantitative Marketability Discount Model

Assumptions

Base (minority, marketable level) 1.00

Growth of Value 12%

Holding period 7-9 Years

Annual Dividends -

Dividend Growth Rate 0.0%

Terminal value of dividends - - - - - - - - -

Terminal cash Flow $1.12 $1.25 $1.40 $1.57 $1.76 $1.97 $2.21 $2.48 $2.77

Present Value $0.92 $0.84 $0.77 $0.71 $0.65 $0.60 $0.55 $0.50 $0.46

Holding Period Return 22%

Implied Discount From Marketable Minority Level Of Value During Expected Holding Period

1 2 3 4 5 6 7 8 9

12% 0% 0% 0% 0% 0% 0% 0% 0% 0%

14% 2% 3% 5% 7% 8% 10% 12% 13% 15%

16% 3% 7% 10% 13% 16% 19% 22% 24% 27%

Holding Pd. Req. Ret. 18% 5% 10% 14% 19% 23% 27% 31% 34% 37%

20% 7% 13% 19% 24% 29% 34% 38% 42% 46%

22% 8% 16% 23% 29% 35% 40% 45% 50% 54%

24% 10% 18% 26% 33% 40% 46% 51% 56% 60%

26% 11% 21% 30% 38% 45% 51% 56% 61% 65%

28% 13% 23% 33% 41% 49% 55% 61% 66% 70%

30% 14% 26% 36% 45% 53% 59% 65% 70% 74%

Note: Assumes dividends are reinvested at the required holding period return

Holding Period

� Advantages

– Allows for flexibility

– Consistent with income approach

– Allows for internal consistency with other valuation assumptions

– Quantitative

� Disadvantages

– Subjective

– Purely theoretical

– Not tied directly to transactions

– Is difficult to determine certain variables

QMDM Approach

Marketability vs. Liquidity

�Mercer’s model is essentially a tool for estimating the effect of the differential in demanded returns.

� There is no factor within a model which quantifies the binary differential between legally marketable securities and legally non-marketable securities.

Marketability vs. Liquidity

�Mercer’s model is essentially a tool for estimating the effect of the differential in demanded returns.

� There is no factor within a model which quantifies the binary differential between legally marketable securities and legally non-marketable securities.

�Similarly, all option models used to estimate a Discount for Lack of Marketability/Liquidity reflect differences in liquidity, without consideration of the core element of marketability.

Option Models as Indicators of

the Discount for Lack of Liquidity

�Bajaj, Sarin, et. al. 2001: Firm Value and Marketability Discounts

Bajaj, Mukesh , Denis, David J., Ferris, Stephen P. and Sarin, Atulya, Firm Value and Marketability Discounts (February 26, 2001). Available at SSRN: http://ssrn.com/abstract=262198 or doi:10.2139/ssrn.262198

� “…it appears that several characteristics of the firm and the restricted stock issue are associated with the discount in pricerelative to the firm’s publicly traded shares. Even if an analyst properly incorporates issue and issuer characteristics, it is premature to label the resulting discount a “marketability discount.”



�Bajaj studied 88 private placements of stocks of publicly tradedcompanies taking place from 1990 through 1995.

– 38 of the placements involved registered shares which were

immediately marketable

– 48 of the placements involved unregistered shares which were subject

to Rule 144 restrictions.

� The following multivariate regression was developed to distinguish between marketable and non-marketable securities:

Discount = a + b1 × Fraction of Shares Issued + b2 × Z-Score

+ b3 × Standard Deviation of Returns + b4 × Registration Indicator.



� In the Bajaj regression the Registration Indicator was set at either a 1 for a registered issue of a 0 for an unregistered issue.

� The b4 factor represents the amount of the observed discount which is due to marketability as opposed to other factors contributing to the discount.

� The b4 factor in the regression was 7.23%. Adjusted r-squared of 32.3%

�Conclusion: “… controlling for all other factors influencing private placement discounts, an issuer would have to concede an additional discount of 7.23% simply to compensate the buyer for lack of marketability.”

�Our firm believes this factor needs to be added to Mercer and option model indications in order to reflect both liquidity and core marketability.

Option Models as Indicators of Discount for Lack of Liquidity

� Numerous Models

� Most widely used for this purpose are closed form models which measure risk by considering the following inputs:

– Time (life of option driven by expected holding period) – major factor

– Risk (as measured by the volatility imputed to the underlying security) –

major factor

– Dividend return (received by holding security rather than option) – major

factor

– Relationship of market price of underlying security and strike price of

option;

Presumed to be equal for this purpose.

– Risk-free rate (what holder could invest at in the absence of holding security) –

minor factor

� None of the above factors relates to access to a market or lack thereof

Is An Option an Asset, or a Measure of Risk, in the Context of

Estimating a Discount for Lack of Liquidity?

� “A Test of DLOM Computational Models”

– John Stockdale, ASA, CPA/ABV

– Business Valuation Review, Vol. 27, Number 3, 2008

� Tested 5 models against observed data from the FMV Restricted Stock Study database. Discounts deemed equal to option premium

– Reasonable Results over relatively short periods but with some problems:

� Chaffee (results decline after peaking)

� Finnerty (discounts > 100% with long holding periods + high volatility)

� Meulbroek (best over all periods; measures against a diversified portfolio)

– Unrealistic Results:

� Longstaff (quickly produces discounts over 100%)

� Tabak (produces discounts of 100% stabilized in a relatively short time frame)



� “Discount for Lack of Liquidity: Understanding and Interpreting Option Models”

–Business Valuation Review, Vol. 28, Number 3, 2009

–Ashok Abbott, PhD

�Reviewed Stockdale article from prior year

�Overcame criticisms of option models which produced irrational discount rates by treating the option as an incremental asset tied to the underlying security rather than as a measure of risk.



�Sample Scenario:

– Stock value is $50.00 and Option Strike Price is $50

– Holding period is expected to be five years

– No Dividends

– Risk Free Rate = 2.75%

– Volatility is estimated at 50%

�Using a simple Black-Scholes model the option value (premium) is

$20.18



Option As Risk Measure Option As An Asset

20.18$

50.00$ = 40%

$20.18

($50.00 + $20.18)= 29%



�Reasons to Treat the Option as A Measure of Risk with No Asset Value:

– For small privately-held companies, there is no opportunity to

purchase an actual option.

– A true asset has the characteristic of producing future cash inflow;

an imaginary option has no such characteristic.

– Any option decays with the passage of time, and a Discount for

Lack of Liquidity does get smaller with the passage of time. A

buyer at the end of the projected holding period (assuming his

assumption of a holding period is equal to the seller’s original

assumption at the Valuation Date) will demand an equivalent

discount. There is no decay.

Review of Case Study Fact Pattern

�No history of material or recent dividends, and no anticipation that any dividends will be paid in the future regardless of free cash flow.

�No history of stock repurchases and no obligation to do so, but company and other shareholders have right of first refusal.

�No plans to go public or for a private sale; for calculation purposes assume a holding period of 8 years based upon anticipated retirement age of youngest member of management. Rate on a 10-year Treasury Bond is 3.0%.

�Volatility (8 years, monthly measures) for JOSB, MW, SYMS, and GPS = 26%

Case Study Calculation Results:

Simple Black-Scholes Protective Put

�Eight year hold = 14.33% (Liquidity only)

�Five year hold = 13.74% (Liquidity only)

� Is the 59 basis point difference a reasonable relationship for three extra years of risk?

�When mathematics defies common sense, on which do you rely?

�“Trust your instruments” only works in airplanes!


Simple Black-Scholes Protective Put

http://hilltop.bradley.edu/~arr/bsm/pg04.html


Finnerty Asian Put Formula

�Same inputs as Black-Scholes Protective Put.

�Eight year hold = 40.04% (Liquidity only)

�Five year hold = 26.27% (Liquidity only)


Finnerty Asian Put


Longstaff Look-back Put

F(T) = (2+σ2T/2)N(√σ2T/2)

http://links.jstor.org/sici?sici=0022-

1082%28199512%2950%3A5%3C1767%3AHMCMAS%3E2.0.CO%3B2-F

_______


Longstaff Look-back Put

� Same inputs as Black-Scholes Protective Put.

� Eight year hold 960% (Liquidity only)

– (Discount is 90.6% if option value is treated as an element of a portfolio)

� Five year hold = 635% (Liquidity only)

– (Discount is 86.4% if option value is treated as an element of a portfolio)

� Base discount (treated as a risk measure rather than portfolio element) approximates 100% with a 150 day holding period.

� Using the option premium from Longstaff in the portfolio context should produce a reasonable upper limit to the discount as a logical smell test.

� Long-Term Equity Anticipation Securities

– Publicly traded, long-term options to buy or to sell an underlying publicly traded

entity

– Put option 14 to 26 months

– American style options

– Cost of option can be a proxy for the minimum DLOM of a closely held company

– Percentage is cost of put/cost of the stock

Using LEAPS for DLOMs

� LEAPS are the best market-based evidence because...

– LEAPS are publicly traded - they reflect all market forces

– LEAPS are valuation date specific - i.e. you can match the LEAPS date to the valuation date of your appraisal assignment

– LEAPS are industry specific - there are over 1000 companies with LEAPS

– LEAPS include many of the Mandelbaum factors, by definition

– LEAPS often can be used like publicly traded guideline companies


� 2007 LEAPS study

� “company size and company risk have clear and major effects on discounts

� profit margin, earnings growth and dividends have minor effects on discounts

� companies with revenues of under $1 billion frequently require discounts of from 17% to 27% and more

� companies with betas of 1.5 or more frequently require discounts of from 16% to 23%”

� 2009 LEAPS study

� “discounts change over time and are not constant in size. Discounts in November 2008 were double those in October 2006.

� discounts vary significantly by industry”


8/2006 11/2008

Mos. To Expiration 14 26 14 26

Count 906 897 1036 623

Median 13.9% 17.4% 33.5% 40.6%

Mean 16.3% 20.5% 36.4% 43.2%

Using LEAPS for DLOMs - Ronald M. Seaman

Source: Discounts for Lack of Marketability And The 2008-2009

Recession pp. 1-2

� www.dlom-info.com Ronald M. Seaman, FASA

– LEAPS: For a market-based Discount for Lack of Marketability

– Discounts for Lack of Marketability And The 2008-2009 Recession

– LEAPS on ETFs Measure Holding Period Risks Among Industries

– So, how can LEAPS help me? (the Clunker Motors Case)

– How to Use LEAPS To Determine A Discount for Lack of Marketability, July 2008

– Letter To The Editor, Business Valuation Update, January 2009, The Effects of Current Economic Troubles on Discounts For Lack of Marketability


Sniff Test:

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8 9 10111213141516171819202122232425262728293031323334353637383940

Indicated discounts over 20 year hold

in six month increments and forumula

Discount = 1 - .87n

“Outrageous” Returns and Market Failure

�Argument is often made that a transaction at indicated high discounts would produce an outrageously high return to the buyer.

�Corollary to that argument is that a seller would never sell at such a discount.

�At the end of 2008 we experienced a market failure where uncertainty regarding ultimate returns led to buyers’ demanding huge discounts and sellers unwilling to part with the assets at that price. There was a market failure.

� The lack of a ready market for non-controlling interests in privately-held businesses suggests that a similar condition exists with respect to those assets.

�Unacceptable as it is, it may be that the actual Discount for Lack of Marketability/Liquidity for certain assets really is 100%.

Reconciling Diverse Discount Indications

�Reliance on a single analytical framework will become progressively less acceptable.

�No one method can stake a claim to being “right”; all have something to add.

�Look for a central point in a scatter-gram of indications.

�Be objective, citing strengths and weaknesses in the various analyses.

�Understand that minor differences in conclusions will almost always occur, and both sides, if reasonable, can compromise.

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