by
Ron J. Lint, ASA, CEO
Business Valuation and ESOP Specialist
ATI Capital Group of Colorado, LLC
453 E. Wonderview Ave., PMB 312
970-577-8030
ron@aticolorado.com
Issue: In recent conversations regarding valuation discounts applied
to business interests that are not actively traded on a major exchange
or over the counter, I have noticed a great deal of confusion regarding
when and how these discounts should be applied. Should a minority interest
discount be applied to all valuations representing a minority ownership
position? Are discounts for lack of marketability always appropriate for
privately-held securities? This three-part article explores the two major
discounts often applied to the valuation of privately-held securities
(see parts one and two).
The Internal Revenue Service recognized the need to reduce the value
of an interest in a corporation where the shares were restricted in their
marketability, and issued Revenue Ruling 77-287 "Valuation of Restricted
Stock." This ruling states in Section 2, "It frequently becomes necessary
to establish the fair market value of stock that has not been registered
for public trading when the issuing company has stock of the same class
that is actively traded in one or more securities markets," and in Section
6.04, "Whether the shares are privately held or publicly traded affects
the worth of the shares to the holder. Securities traded on a public market
generally are worth more to investors than those that are not traded on
a public market."
According to SEC Accounting Release No. 113, restricted securities are
often purchased at a discount from the market price of outstanding unrestricted
securities of the same class, reflecting the fact that securities that
cannot be readily sold in the public marketplace are less valuable. Eight
other independent studies support a long-term historical average discount
of approximately 35% for transactions in restricted stock compared with
the prices of their freely traded counterparts (see table below).
The Silber Study found that: "The discount on restricted stock varies
directly with the amount of restricted stock relative to publicly traded
stock and inversely with the credit worthiness of the issuing company.
That credit-worthy companies must offer price discounts of more than 30%
to sell a significant block of restricted stock illustrates the importance
of liquidity to the valuation of common stock."
In an update to the SEC Study, FMV Opinions, Inc. examined more than
100 restricted stock transactions from 1979 through April 1992. The FMV
study corroborates the conclusions of the SEC study that the size of the
marketability discount for restricted stock is often a function of the
company's revenues, earnings, trading activity and the exchange on which
the stock was traded. The study also found marketability discounts were
in the 30-40% range for corporations with market capitalization of less
than $50 million.
Conclusion: The application of supportable discounts depends on
the starting point of the valuation numbers and the facts and circumstances
of each assignment. Making broad assumptions concerning the application
of these major discounts is very unwise. Consult with your valuation professional
for the specifics of each case.
Part One ·
Part Two ·
Part Three
