Mercer using a 1% COVID-19 risk premium—for now

BVWireIssue #213-1
June 3, 2020

discount for lack of marketability (DLOM)
risk analysis, discount for lack of marketability (DLOM), quantitative marketability discount model (QMDM)

Veteran business valuer Chris Mercer (Mercer Capital) was a keynote speaker at the New York State Society of CPAs Business Valuation/Litigation Services Conference, which was held online on May 18. Mercer’s session covered his “integrated theory” and addressed the market participant acquisition premium (MPAP) and the discount for lack of marketability (DLOM). He is the developer of the quantitative marketability discount model (QMDM) for estimating a DLOM. QMDM is a shareholder-level discounted cash flow model that values interests in a business in the context of an appraisal of the entire enterprise, the value of which is a function of expected cash flows, their growth, and the risks associated with achieving them.

Focus on cash: In response to a question from the audience regarding the impact of COVID-19 on the marketability discount using the QMDM, he responded that he and his firm are focusing on projections of cash flows and growth. As for risk, he says: “We believe that the overall riskiness is, hopefully temporarily, increased and are adding 1% of ‘COVID risk’ premium in discount rate development for the time being. That decision was made after considerable slicing and dicing of public market performance and multiples. We attempt to focus on cash flow rather than attempting to ‘solve’ the pandemic issues with a large dose of incremental risk discount rates. We will revisit this issue frequently.”

As for the impact of COVID-19 on DLOM using the QMDM, there is no obvious answer because of the assumptions that must be made in terms of cash flow, growth, and risk, as he explains in his blog.

Mercer also told the audience that the third edition of Business Valuation, An Integrated Theory, a book that he co-wrote with Travis Harms (Mercer Capital), will be out this September. The book describes the QMDM in detail.

We’ll have more coverage of the NYSSCPA conference in next week’s BVWire. Kudos to conference chairs Mitchell Chosak (FSA LLC), Jean Han (Clarion Consulting Associates LLC), and Andrew Park (Andrew M. Park, CPA, PC).

Please let us know if you have any comments about this article or enhancements you would like to see.