Value and Marketability: determinants of the DLOM

Introduction

The summa divisio in the corporate landscape is the one between listed (public) and unlisted (private) companies. The recent past is clearly marked by a shift from public to private.  From a financial (valuation) point of view, the main drawback associated with unlisted companies is the private company discount (also referred to as the discount for lack of marketability or the illiquidity discount). The private company discount has been extensively discussed in the literature and several methodologies have been proposed to estimate its size [add references].

The dynamics and size of the private company discount are still not entirely understood and applying the discount degenerates often to an ad hoc deduction from the estimated marketable value of an asset. The current practice is to simply deduct a percentage between 20%-40% without a compelling economic reasoning.

The ambition of my analysis is to single out the components of this discount that are under the control of the company and to see whether and to what extent they can be neutralized in order to (partially) reverse the discount. This would create value for the company and its shareholders alike and might help change the (closed) eco-system in which private companies typically operate. As discussed in the paper, recent legislative developments and technology can be instrumental in reversing specific components of the discount. In that respect, the analysis is more relevant today than it has ever been before. 

Models and methodology

The available models and scientific papers suggest that the total private company discount is made of various components and that it is determined by variables such as the industry, the company size, its profitability, the stock volatility and trading activity. [add references]

I hypothesize that, in addition, legal and contractual transfer restrictions and the existence of (micro) liquidity, i.e. a theoretical opening to trading must have an important impact. I refer to these latter two elements as “marketability” and to examine their specific impact on the private company discount.

In order to do this, I use the court cases method. This method has not been used (at least not in a systematic manner) and although this method has certainly also limitations, it might serve the purpose. Indeed, it can be feared that court decisions rely (directly or indirectly) on other methods or references that are deemed useful or convincing and that they may be rather concise in their justification of the discount. Yet they offer the benefit of a referring to a very specific percentage discount (rather than a range of values) and the two elements referred to above are typically the matters that courts of law will explicitly consider.

The paper will consider relevant cases in at least 4 jurisdictions and endeavor to single out the marketability discount.

Scientific and societal relevance

The analysis is novel in two ways: first because it concentrates on the specific elements of the private company discount that are under the control of the issuer and second in that it is based on court cases that explicitly decide to apply a private company discount.

The research is probably also timely in that coincides with legislative and technological developments that make it actionable. In Belgium, for example, private companies tend to register stock in paper share registers. These are now being law allowed to be kept in electronic form and nothing prevents shareholders from using technology to propose their electronic shares for sale. It might thus well be that shareholders “push” their issuers to lift contractual transfer restrictions and to change the way in their shares are being held, in order to benefit from micro liquidity and enhance the value of their holding (by reducing the discount).