Perhaps nothing in business valuation is more controversial than the discount for lack of marketability (DLOM). This one adjustment can have a sizable impact on clients' tax obligations. So, naturally, one question frequently lingers in attorneys' minds at the end of estate-planning engagements: Did the business appraiser select an appropriate discount?
. . . We offer a way to calculate DLOM using a unique empirical approach that directly compares privately held companies to publicly traded counterparts.
So begins a new article, “The Matched Pairs Approach,” by Pepperdine University professors Maretno Agus Harjoto and John K. Paglia in a recent issue of Trust and Estates (Oct. 2009, copy available to subscribers only). In their study, the authors first considered “matched pairs” of data, linking private firm sale transactions in Pratt’s Stats® with a similar-sized public comparables from the Compustat database for the same year and industry. They also matched each selected Pratt’s Stats transaction with an industry average based on year and three-digit NAICS code. Ultimately, they conclude that “DLOMs for private companies should be dramatically larger than what's currently being claimed.”
In fact, the Matched Firm study resulted in an average discount of nearly 70% in 1999 to a high of almost 81% in 2005, according to Dr. Stanley Pollock, whose analysis of the article appears in the latest Business Valuation Notes (Nov. 2009) from the Minnesota Business Valuation Group. “The studies display discounts which fluctuate with economic changes, but the discounts are consistently larger than obtained using other methods,” Pollack observes. “The research demonstrates that not only is the potential discount larger for private companies when compared to public company than appraisers have been applying, but that the discount research also supports the notion that a DLOM is relevant for controlling interest values.”
Interestingly, the October 2009 Trust and Estates contains a second article, “The Holy Grail of a Valid DLOM,” by Hans P. Schroeder, describing a “real world” regression analysis based on selected data from the FMV Opinions Restricted Stock Study™ that is “simple to use and, in… testing so far, give sensible results. It remains to be seen how the approach will stand up in court,” Schroeder concludes, “but I believe its chances are good.”
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