By the time I came into the business valuation profession, appraisers recited a small number of restricted stock studies to conclude that typical discounts were in the range of 25% to 45%, and therefore, that marketability discounts for illiquid minority interests of private companies should be in that range, as well.
But Professor William L. Silber wrote an article in the respected Financial Analysts Journal that told a different story. However, business appraisers ignored wisdom found in the Silber Study and only took its conclusion that the average discount in the study was 34% as confirming of the existing lore.
Silber, William L., “Discounts on Restricted Stock: The Impact of Illiquidity on Stock Prices,” Financial Analysts Journal, July-August 1991, pp. 60-64.
Summary statistics from the Silber Study are provided in Exhibit 8.4 of the forthcoming Business Valuation: An Integrated Theory Third Edition, which will be available for purchase on Amazon.com on October 13th.
But wait, there’s more. Professor Silber looked at his sample of 69 restricted stock discounts and noticed a distinct difference between the companies that had lower discounts (less than 35%) and higher discounts (greater than 35%). The study provided additional color as found in Exhibit 8.5 of our new book, which was co-authored with Travis Harms.
What a difference a more informed look makes! The average for transactions with discounts exceeding 35% was 54%, while the average for transactions with discounts less than 35% was 14%. What could have caused this difference? Professor Silber provided summary statistics for the two subgroups as shown above. Simply put, the companies with lower discounts were just more attractive in terms of cash flow, perceived risk, and likely expected growth than the companies with higher discounts. They were larger in terms of revenue and market capitalization and more profitable than the companies in the larger discount sample.
A picture is helpful. I wrote about the Silber Study in Quantifying Marketability Discounts (which introduced the QMDM) in 1997 and provided a chart similar to Exhibit 8.6 from the new book.
As a young business appraisal profession, we should have known, within a reasonable time after the Silber Study was published, that restricted stock discounts, in and of themselves, provide no valuation information. Assume that a restricted stock transaction occurred at $7.50 per share while the freely traded price was $10.00 per share. What do we know from this observation?
- The public price was $10.00 per share
- The restricted stock transaction price was $7.50 per share
- The discount to the public price was $2.50 per share or 25%
- The public price reflected a 33.3% premium to the restricted share price
That’s it. There is no economic or valuation information in one restricted stock observation that can be used to apply to the pricing of private companies. If there’s no economic information in one observation, we do not gain information by looking at many discounts, or averages of many discounts.
What is the root cause of restricted stock discounts? Why did/do they exist? We will tackle that question in the next post.
Until then, pre-order your copy of Business Valuation: An Integrated Theory Third Edition.