Mercer’s Musings #5: Pre-IPO Studies/Discounts and Marketability Discounts

My musings on the use of restricted stock discounts to estimate marketability discounts (or DLOMs) have led me to the conclusion: Restricted stock studies/discounts cannot be used to estimate DLOMs in any credible, standards-compliant manner. This fifth post in the musings series takes a look at the usefulness of pre-IPO discounts in estimating marketability discounts.

Mercer’s Musings #4: Factors to Consider in Valuing Partial Ownership Interests

Following “Mercer’s Musings” 1-3, Mercer’s Musing #4 examines the guidance found in “Procedural Guideline -2 (PG – 2) Valuation of Partial Ownership Interests” in the ASA Business Valuation Standards.  Procedural Guidelines (PG) are designed to provide more detailed guidance for consideration by business appraisers than found in the base standards themselves.

There is a great deal more to valuing illiquid minority interests than “guessing” at a marketability discount based on vague references to dated and non-comparable restricted stock transactions or studies. All appraisers would be well-served to read PG – 2 Valuation of Partial Ownership Interests in the ASA Business Valuation Standards.  Doing so should provide a different and more realistic view of the valuation of illiquid minority interests of private companies than is held by many appraisers.

Mercer’s Musings #3: Marketability Discounts Re Two Hypothetical Minority Interests

In Mercer’s Musings #3, I address this basic quantitative derivation of marketability discounts for Companies A and B. As valuation is a function of expected cash flows, growth, and risk, any methodology failing to account for these factors is inadequate. Through a hypothetical comparison of two identical corporations with differing minority interests, I emphasize the value of a nuanced approach to valuation, suggesting that reliance on outdated averages from restricted stock studies is insufficient for accurate marketability discount estimation.

Mercer’s Musings #2: Using Restricted Stock Studies to Support Marketability Discounts

In “Mercer’s Musings #2,” the focus shifts to the examination of restricted stock studies and their application in determining marketability discounts for gift and estate tax appraisals, offering valuable insights for appraisers across all credential spectrums. Highlighting the inherent challenges of such studies, I underscore the lack of economic relevance these studies hold in contemporary valuation scenarios, particularly emphasizing their disconnect with current private company valuations. Through an analysis and a hypothetical valuation scenario, I invite readers to explore the nuanced complexities of applying marketability discounts, advocating for a quantitative approach informed by common sense, judgment, and reasonableness.

Mercer’s Musings #1: USPAP and the Internal Revenue Service

Many years ago, I wrote a column for the Business Valuation Review that the editor, Jay Fishman, FASA, called “Mercer’s Musings.” In this blog and with this post, I reintroduce “Mercer’s Musings” because I would like to reflect on a number of seemingly unsettled issues in the business valuation world. This first musing relates to the need (or not) to comply with the Uniform Standards of Professional Appraisal Practice promulgated by The Appraisal Foundation in gift and estate tax appraisals prepared for the Internal Revenue Service.

The Basis for Control Premiums

Control/Lack Thereof or Expected Cash Flow, Growth, and Risk?

My co-author, Travis W. Harms, CFA, CPA/ABV, and I have been doggedly insisting that business valuation questions, issues, premiums, discounts, and more be viewed through the combined lens of expected cash flow, its expected growth, and the risks associated with achieving the expected cash flows.

Until the latter 1990s, it was thought that buyers of companies paid premiums (over publicly-traded prices of targets) for elements of control.  The current view is that buyers of companies pay for expected changes, post-acquisition, in combined cash flows and potentially reduced risk.  Unfortunately, the valuation literature appears slow to recognize this change in thinking from paying for control (or lack thereof) to paying for relevant value based on the expected cash flows of a business or an interest in a business from the viewpoints of market participants at the respective levels.

Fair Market Value and the Nonexistent Marketability Discount for Controlling Interests

This post provides a discussion of several implications of the definition of the standard of value known as fair market value. We focus first on the definition of fair market value. Next, we examine the hypothetical negotiations conducted by hypothetical buyers and sellers in fair market value determinations and the implications of those negotiations.

We then look at the implications for the so-called “marketability discount for controlling interests.” We look at this “discount” from the vantage points of the definition of fair market value, the integrated theory of business valuation, and recurring and incorrect rationales for the discount.

The 2023 AICPA Business Valuation Conference and One Thought on Valuation Adjustments

I have heard many appraisers suggest that one should not normalize owner compensation when valuing minority interests “because the minority shareholder cannot change compensation.” I’d like to address this issue in this post.

USPAP Standards Rule 9-4 Creates a Problem for Business Appraisers

There were significant changes in Standards Rule 9-4 of the Uniform Standards of Professional Appraisal Practice regarding the development of business appraisals between 2005 USPAP and 2006 USPAP. The changes relate to moving from following procedures and considering approaches to a focus on developing “credible appraisal results” and analyzing “the effect on value, if any” or a number of quite specific valuation factors.

There were changes to Standards Rule 9-4(a) and 9-4(b) that shift emphasis to credible appraisal results and to introduce a focus on intangible assets for the first time. Standards Rules 9-4(c) and 9-4(d) were completely new and require appraisers to “analyze the effect on value” of a number of very specific factors that we will discuss in this post.

Appraisers who must follow USPAP, and that includes all members of the American Society of Appraisers and any appraisers conducting appraisals for gift and estate tax purposes or for other purposes involving the federal government, these standards apply. The rules apply, practically, to almost all appraisers, including those holding ABV and CVA designations.

And now for a bold conclusion at the outset: Many appraisers who focus on using restricted stock studies and pre-IPO studies as a basis for determining marketability discounts for illiquid minority interests have historically not been and are currently not providing standards-compliant appraisals for their clients.

And that’s a problem.