When the 500 (or so) attendees at an AICPA BV panel discussion on discounts for lack of marketability (DLOM) were asked if they employ a marketability discount when valuing controlling interests, the vast majority—about 75%—raised their hands. This prompted moderator Linda Trugman and panel members Chris Mercer, Ron Seigneur, and Mel Abraham to discuss—and unanimously agree—that doing so may be without conceptual basis. “It is the cash flows of a business which give rise to value today—and tomorrow and the next day, until it is ultimately sold,” Mercer says, responding to BVWire’s request for further explanation. The controlling shareholders have full benefit of the cash flows until sale. To establish a marketability discount for controlling interests, “there would have to be an unobservable value from which this nebulous discount is taken in real transactions,” Mercer says, “because the multiples that are observed in the marketplace are necessarily net of any and all discounts!”
Anyone who can provide a conceptual basis for this “popular” discount should do so, he adds, “else all those who use it have no basis for applying it,” Mercer says, “and it becomes a discount of convenience.” Take his logic one step further: “No valuation concept (or discount or premium) has any meaning absent a conceptual basis for it.” The conceptual basis for the value of an illiquid, minority investment, for example, is the present value of future cash flows, derived from the enterprise and received by the security holder, discounted to the present at an appropriate discount rate, for the expected holding period of the investment.
“And don’t forget,” Mercer notes, that since 2005, USPAP has required consideration of the “holding period, interim benefits, and the difficulty and cost of marketing” of the subject interest (see SR 9-4(d)). Yet he was surprised to see how many AICPA BV attendees said they still apply averages of restricted stock studies or benchmarking analysis. “These methods simply do not enable the appraiser to analyze the effect on value, if any, of differences in expected cash flow (from those of the enterprise), differences in expected growth, or differences in risks over relevant expected holding periods.” Just about 10% to 15% of attendees indicated using Mercer’s QMDM. “I think we’ll see that changing. When we meet again at the next conference,” he predicts “the number of QMDM users—or users of shareholder-level DCF models—will be significantly higher.” For more discussion, visit the extensive article library at Mercer Capital, including “Quantifying Marketability Discounts: Valuing Shareholder Cash Flows.”
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