We’re still getting responses to the ongoing discussion on how valuation analysts derive the discount for lack of marketability (DLOM), not only from restricted stock studies, but other commonly used models. For instance, “any suggestion . . . that two alternative tools (the QMDM and Option Pricing Models) are less subjective than adjustments from [restricted stock] studies is surprising,” says Terry Lloyd (FSG).
“Actually, what we all seem to be grasping for is a magic formula to determine a LARGE marketability discount,” says Nancy Fannon (Fannon Valuation Group).“Maybe instead we should ask ourselves what our lack of being able to find one tells us.” In other words, she adds:
Private [company] valuation analysts already take enormous effective discounts for size, which is correlated with illiquidity, when we use a public market rate of return. If analysts don’t know “how much” illiquidity is already built into their discount rate, then how can they know “how much more” to take? This strikes me as the crux of the problem plaguing the DLOM debate (that, and the utter lack of direct evidence of an appropriate discount over and above this amount). Frankly, it is the same problem that has plagued the S corp. debate; we never had a discussion about how much tax penalty was baked into the market returns we use, and [thus] how could we possibly know how much to remove? Without that understanding, these round-robin discussions on DLOM and S Corps will continue to go nowhere.Along these lines, Mike Pellegrino (Pellegrino & Assoc.) points out, “Ultimately, a DLOM is a time-value of money issue. I want to sell a share in a private company at a certain price. When do I get my cash? We as a profession need to focus on the theoretical model that explains that relationship most consistently and across the entire economy,” he says. “Isn't such objectivity a crucial virtue to our profession?”
Otherwise, the protraction of the debate and its proprietary positions may start to look like professional “arrogance,” says G. Christopher Wright, an attorney and CPA. “No wonder courts routinely ignore valuation reports,” he says. Worse—we might ask whether courts could use the current controversy surrounding DLOM to find a lack of “common acceptance by professionals in the field,” one of the four requirements of reliability underDaubert. E-mail your thoughts to the editor.