General DLOM Information DLOM Job Aid page 8 subject corporation's privately traded securities vis-a-vis its publicly traded securities or, if the subject corporation does not have stock that is traded both publicly and privately, the cost of a similar corporation's public and private stock ; 2 an analysis of the subject corporation's financial statements; 3 the corporation's dividend-paying capacity, its history of paying dividends, and the amount of its prior dividends; 4 the nature of the corporation, its history, its position in the industry, and litrrature economic outlook; 5 the corporation's management; 6 the degree of control transferred with the block of stock to be valued; 7 any restriction on the transferability of the corporation's stock; 8 the period of time for which an investor must hold the subject stock to realize a sufficient profit; 9 the corporation's redemption policy; put option valuation sample literature review 10 the cost of effectuating a public offering of the stock to be literayure, e. However, these arbitrage opportunities are really short lived. One year median discounts ranged from 8. An introduction into Data Mining and Knowledge Discovery. Students will research the accounting literature, with the objective of critically evaluating the present status and future course of accounting thought. Students are required to submit extensive critiques and to participate in panel discussions.




The web page width has also been modified to make viewing the pdf document easier. My text version remains following to preserve the ability of search engines to find these pages. Please allow time for your pdf reader to open. Always read Section E, Evaluation and Recommendations, in conjunction with Section D, Summary of Approaches to DLOM. Note that while certain of the studies reviewed may indicate large discounts, such discounts are not appropriate in all facts and circumstances.

The Valuation Analyst must have a clear understanding of the facts and circumstances of each interest to be valued, use professional judgment in choosing a DLOM just as is done for all other parts of a valuation, and apply a reasonableness test. In other words, the Analyst must get behind the data used to support a DLOM choice rather than simply using summary statistics and resulting conclusions developed by somebody else. Acknowledgements The DLOM Team would like to extend their thanks to the following IRS valuation professionals who put option valuation sample literature review drafts of this job aid: Monty Careswell, CPA, ASA, CVA TeamDenver, CO Paul Elkins, CPA, CVA TeamKing of Prussia, PA James Peacock, AVA TeamAustin, TX Terry Savill, AVA TeamFort Worth, TX Also like to thank Counsel reviewers as coordinated through Steve Blum, and Engineer Manager Jack Jolly who handled the design and upload to the intranet.

Table of Contents DLOM Job Aid A. E XECUTIVE S UMMARY S UMMARY OF A PPROACHES TO DLOM B ENCHMARK A PPROACHES 12 a Restricted Stock Studies 12 b Pre-Initial Public Offering Pre-IPO Studies 19 c Restricted Stock Equivalent Analysis 23 d Cost of Flotation 25 e Mandelbaum Factors, Judge Laro, 27 2. A NALYTICAL A PPROACHES 39 a Karen Hopper Wruck 41 b. Hertzel and Smith 43 c. Bajaj, Denis, Ferris and Sarin 46 d. O THER A PPROACHES 54 a QMDM Christopher Mercer 54 b NICE William Frazier 56 c NERA David Tabak 59 d Partnership Profiles Partnership Spectrum 62 e Public vs.

S OURCES AVAILABLE TO IRS V ALUATION A NALYSTS 76 Table of Contents DLOM Job Aid F. Access is limited to those who have been granted permission. For those who do not have access, please contact Jack Jolly. If needed, contact a DLOM Team member for its availability. Executive Summary DLOM Job Aid page 1 A. Executive Summary In June a team was formed for the purpose of exploring and developing information to assist valuators in the Internal Revenue Service Large and Mid- Size Business LMSB Engineering Program in dealing with the Discount for Lack of Marketability DLOM as such is used in valuation reports.

Among the activities to be undertaken by the team was the clarification of the definition of Discount for Lack of Marketability, exploration of the state of the art in estimating this discount, analysis of current estimating models, review of court commentaries, and documentation of any concerns with the use of the various approaches considered. This information should be of value not only to our own personnel but also to our valuation customers.

Background: Initially, the team was charged with assisting Howard Lewis, Engineering Program Manager, who had been asked to act as a moderator for a summit on DLOM by Judge David Laro in September, At the end of AugustHoward Lewis retired. In October LMSB Field Specialists reorganized and the position of Program Manager was eliminated. However, given the convening of this private sector summit, it was anticipated that there would be renewed energy devoted to this issue.

The development work of this team was to take into account outcomes of the September summit and provide guidance to our employees. Mike Gregory, Engineering Territory Manager, was asked by Howard Lewis to initiate this process on behalf of the Engineering Program. Mike Gregory championed the work of the team and Sue Kurzweil, National Engineering Business Valuation Team Lead from Independence, Ohio was selected as the Project Manager.

A conference between Howard Lewis and Mike Gregory on May 30, caused the drafting of the charter that initiated this project. Objective: The team researched the state of art in DLOM starting by defining DLOM and differentiating it from such related areas as Discount for Lack of Liquidity DLOL and Discount for Lack of Control DLOC. We reviewed longstanding methods for estimating DLOM. Our hope was to provide a quality, timely analysis that will assist employees in the field working DLOM issues.

Approach: It is recognized that the DLOM issue is primarily factual in nature. However, it is also recognized that many of the aspects of this issue have been explored by the courts and the courts have defined, in part, what facts may be A. Executive Summary DLOM Job Aid page 2 given weight in determining the DLOM on a given case. His willingness to provide a current summary analysis on this topic was vital to the work of our team.

The information provided in this document is thought to address issues on the most current approaches to DLOM. Any model or estimating technique can be misused and abused. The commentary that follows addresses various approaches and models associated with the quantification of a DLOM as of the date of this report. Further updates and changes to these models or techniques could render some of these comments obsolete.

Conclusion: This Job Aid is meant to provide a background and context for the Discount for Lack of Marketability as such is commonly applied in business valuation analyses and reports. It reviews past and existing practices and attempts to provide insight into the strengths and weaknesses of these practices. It is not meant to provide a cookbook approach to evaluating a marketability discount as proposed by a taxpayer or to setting a proposed marketability discount in the case of an independent governmental appraisal.

It is emphasized that, all background and existing practices aside, the establishment of a Discount for Lack of Marketability is a factually intensive endeavor that is heavily dependent upon the experience and capability of the valuator. By bringing the included material together in one document, we are striving to make the job of the IRS valuation analyst easier. We do not mean to provide guidance as to reasonable levels of marketability discounts that would prevail in all situational contexts or to imply that the IRS has any policy per se in the evaluation or the determination of such discounts.

Introduction DLOM Job Aid page 3 B. Introduction The application of the Discount for Lack of Marketability DLOM can result in a significant value reduction as compared to the pro rata value of a business interest. These studies, methods and models can be complex, can indicate widely diverse conclusions, and may be appropriate in only certain limited situations. The business valuation profession does not identify acceptable or unacceptable methods for estimating marketability discounts, although some individual practitioners have their own preferences and frequently disagree as to the best approach.

Research in DLOM continues for improved data sources and theory. Some of this research is published primarily as an academic pursuit but is untested in practice. The purpose of this job aid is to assist IRS valuation analysts in their examination of and their independent determination of DLOM and to help them to better understand the numerous available approaches. We will endeavor to explain the intent of the approaches most widely relied upon by practicing valuators as to how each estimates DLOM.

We will identify the parameters used in a given approach, the strengths and weaknesses of the approach, the view of the valuation community concerning the approach, and what the courts have had to say about the approach, if anything. The DLOM Team formed to consider discounts for lack of marketability includes: Name Role POD AVA Issue Champion Engineering Territory Manager St.

Paul, MN Sue Kurzweil, CPA, ASA Project Manager National Business Valuation Issue Coordinator Independence, OH Jeff Myers, ASA, AVA Research Analyst Engineering Team Manager Columbus, OH Laura Goldberg, AVA Research Analyst Engineer Plantation, FL Ernie DeRosa, AVA Research Analyst Financial Analyst New York, NY James McCann, ASA Research Analyst Financial Analyst San Francisco, CA Aberdeen Sabo Advisor Estate Tax Attorney Independence, OH B.

Access is limited to those who have been granted permission see Engineering Program National Shared folder for information on mapping the network drive to your computer. If needed, contact a DLOM Team member to see if it is available in paper format. General DLOM Information DLOM Job Aid page 5 C. General Marketability Discount Information 1. An example is publicly-traded stock on the New York Stock Exchange, where the owner can order the sale and the proceeds are deposited in a bank account in three days.

In the alternative, a lesser price is expected for the business interest that cannot be quickly sold and converted to cash. A primary concern driving this price reduction is that, over the uncertain time frame required to complete the sale, the final sale price becomes less certain and with it a decline in value is quite possible. Accordingly, a prudent buyer would want a discount for acquiring such an interest to protect against value loss in a future sale scenario.

Liquidity What is liquidity? Liquidity is the ability to quickly convert property to cash or pay a liability. Niculita, Valuing put option valuation sample literature review Business, The Analysis and Appraisal of Closely Held Businesses5 th ed New York: McGraw Hill,p. DLOM Job Aid page 6 Said another way, Liquidity is the ability to readily convert an asset, business, business ownership interest or security into cash without significant loss of principal.

Compare Liquidity to the definition of Marketability: the capability and ease of transfer or salability of an asset, business, business ownership interest or security. A Discount for Lack of Liquidity DLOL is an amount or percentage deducted from the value of an ownership interest to reflect the relative inability to quickly convert property to cash.

How does Liquidity differ from Marketability? These terms are often used interchangeably, although there is a technical distinction between them. Factors Influencing Marketability Identified Factors that can have an influence on marketability are numerous. A prominent Tax Court case set forth factors for consideration of DLOM. The Mandelbaum Factors were set out in Mandelbaum v. The factors and the analysis that go with them are considered by many valuators to form a good conceptual basis for thinking about and quantifying DLOM.

Some common factors that have been identified in various studies as impacting marketability are listed below and are modeled after the Mandelbaum factors. The first set of factors relate to the characteristics of the subject company. The second set of factors relate to the characteristics of the subject interest. Ascertaining the appropriate discount for limited marketability is a factual determination. Critical to this determination is an appreciation of the fundamental elements of value that are used by an investor in making his or her investment decision.

A nonexclusive list of these factors includes: 1 The value of the C. General DLOM Information DLOM Job Aid page 8 subject corporation's privately traded securities vis-a-vis its publicly traded securities or, if the subject corporation does not have stock that is traded both publicly and privately, the cost of a similar corporation's public and private stock ; 2 an analysis of the subject corporation's financial statements; 3 the corporation's dividend-paying capacity, its history of paying dividends, and the amount of its prior dividends; 4 the nature of the corporation, its history, its position in the industry, and its economic outlook; 5 the corporation's management; 6 the degree of control transferred with the block of stock to be valued; 7 any restriction on the transferability of the corporation's stock; 8 the period of time for which an investor must hold the subject stock to realize a sufficient profit; 9 the corporation's redemption policy; and 10 the cost of effectuating a public offering of the stock to be valued, e.

For more on Mandelbaum, refer to the Benchmark studies at D. However, common sense and the courts have emphasized that a willing seller must also be considered. In considering the market for a subject interest, the applicable market in which a hypothetical willing buyer may be found need not be one that includes the general public. The courts have determined that it is sufficient if there are potential buyers among those closely connected with a corporation.

USCt. CIR11 BTAthe court stated "we do not construe a fair market as meaning that the whole world must be a potential buyer, but only that there are sufficient available persons able to buy to assure a fair and reasonable price in light of the circumstances affecting value". DLOM Job Aid page 9 marketable securities held in a partnership put option valuation sample literature review court stated that "In our opinion, neither the decedent nor her estate nor a hypothetical seller would have sold the stock of either company for less than that which could have been realized through liquidation.

We further believe that a hypothetical purchaser would be willing to pay such an amount. Marketability of Minority vs. Controlling Interests There is little dispute that minority interests in non-publicly traded entities lose value due to lack of marketability. However, the issue of applying a discount for lack of marketability to a controlling interest is a controversial issue 7 amongst valuators.

Some believe that there should be little or no discount for lack of marketability on a controlling interest, while others believe there should be a discount applied. Most agree that any marketability discount for a controlling interest should be less than the discount for a minority interest in the same entity. The controlling interest owner will be able to sell his or her business interest in one of two ways: a public offering or a private sale. Therefore, it follows that the controlling interest may not be fully marketable.

Among valuators who apply DLOM to controlling interests, it is generally agreed put option valuation sample literature review DLOM of a controlling interest is less than that for a minority interest. DLOM Job Aid page 10 5. Sample Initial IDR Items on Marketability The evaluation of the appropriateness of a discount for lack of marketability requires the collection and analysis of a substantial amount of information about the entity involved and the subject interest in that entity whose marketability is being considered.

We provide below a list of typical inquiry areas that can be put forth in Information Document Requests toward the end of collecting such information. List of all marketable securities description, number, cost value shown on the latest financial statements [cash-equivalent securities might lower liquidity risk on a company-wide basis] e. List of all non-marketable securities and investments description, number, cost value shown on the latest financial statements [can provide information on how long it might take to liquidate non-marketable assets] f.

Breakdown of adjusted cost basis for each of the marketable and Nonmarketable assets owned by the company on the valuation date [can provide information on built-in capital gains tax expense to liquidate the company] g. General DLOM Information DLOM Job Aid page 11 i. Company articles of incorporation and amendments, by-laws and amendments or partnership agreements and amendments [by-laws might address restrictions or procedures for transfer of shares] k. Complete financial statements of the company for the five fiscal or calendar years prior to the valuation date, including balance sheets, income statements and cash flow statements [can provide additional information for evaluating lack of marketability risk] o.

Complete income tax returns for the five fiscal or calendar years prior to the valuation date, including any audit adjustments [tax returns might include details that are not stated within the regular financial statements] p. Summary of Approaches to DLOM There have been numerous approaches taken by researchers and practitioners for determining the appropriateness of allowing a discount for lack of marketability in the valuation of a business interest and in estimating the magnitude of such a discount.

For discussion purposes, we have classified these approaches into four categories: 1. Benchmark study approaches, 2. Analytical approaches and 4. These categories are discussed individually in this section of the job aid. There are then certain derivative approaches that have spun out of the basic approaches. We start our discussion with the first of the primary categories -- restricted stocks. We then cover Pre-IPO studies and conclude this section with brief discussions of certain approaches derived from the benchmarks.

The restricted stock studies have been cited and analyzed in numerous court decisions, sometimes with favorable consideration by the court and sometimes with no real consideration at all. The premise behind the restricted stock studies is that the effect of lack of marketability can be quantified by comparing the sale price of publicly traded shares to the sale 9 According to the Securities Act of Section Because the holder of restricted common stock is prohibited from selling any of the stock for full yearthereafter holding period is six months and has additional constraints on the amounts that may be sold for an additional year, the restricted stock is significantly less liquid and therefore less valuable than its unrestricted counterpart.

This restriction on marketability for the restricted shares is time-limited but does act to affect the ability of the holder to trade the shares during the restriction period. Under SEC rules this restriction period has been either one or two years depending upon the time of issuance of the shares. Many different researchers have collected data on restricted stocks and have compared them to their publicly traded counterparts beginning in The studies conducted have included various time periods for collecting the data and have generated a number of summary statistics to describe the data analyzed.

In recent years, as the discipline of business valuation has continued to evolve, the valuation communities and the courts have taken an increasingly critical view of simply beginning with a summary statistic from a group of studies and going from there, either by accepting the statistic as is or adjusting it without a believable explanation.

Attention has turned instead to getting behind the data itself and deriving an appropriate discount from the data as such relates to the case at hand. This evolution needs to be understood by the valuator and duly considered in using restricted stock studies as an approach to DLOM. Restricted stock studies are published, empirical studies, the most often cited of which are indicated below.

Because SEC restricted stock rules prior to required investors to hold such stock for at least two years and after to the present for at least one yearthe difference between prices at which restricted stocks were issued relative to freely traded stocks of the same company are considered a proxy for a marketability discount for non-publicly traded stock. This analogy is considered to be appropriate since non-publicly traded stocks are also limited in their immediate marketability. Each of the reviewed restricted stock studies is provided in electronic format on the Engineer shared folder see instructions to access at see Engineering Program National Shared folder for information on mapping the network drive to your computer.

A summary of these studies is provided on the next page. Schweihs, eds, The Handbook of Advanced Business Valuations New York: McGraw-Hill, This is a wide range in terms of central tendency and indicates the probability of a much wider range across the individual data points. Further, the sample sizes in these studies are small, most involving less than individual data points such that the reliability of the summary statistics is subject to considerable data variation.

This factor emphasizes the need to get into the data itself instead of staying at the summary level. One explanation for this phenomenon is the increase in volume of privately placed stock under Securities and Exchange Commission SEC Rule a in the past several years. Also, a change in the minimum investment holding period required by the SEC under Rule from two years to only one year-took place as of April 29, Considerable raw data was available for analysis and many different independent analysts worked the data and produced numerical results.

A discount for lack of marketability is applied as part of the valuation process to estimate the fair market value of an asset or security. With some of the data in the studies reaching back toit may not reflect the dynamics of current market conditions. All except the last two studies use market data D. The SEC, effective Aprilamended Section to require only a one-year holding period by investors, implying a lower discount for lack of marketability.

The current law, effective Februarynow requires only a six month holding period by investors of small companies, however no new restricted stock studies have been published, as of yet. Using measures of central tendency without an examination of the underlying data leads to the opportunity for mischaracterization of the true restricted stock trading patterns.

Two components to restricted stock study data: a market access component liquidityand a holding period component. The holding period component deals with the SEC Rule required holding period for a restricted stock sale. Holman concluded that the hypothetical purchaser would demand and get a price concession to reflect the market access component of the marketability discount but would get little if any price concession to reflect the holding period component of that discount. IRS Engineer, Tom Kelley, AVA, completed an analysis 10 of the transactions in the FMV Restricted Stock database in The purpose was a to analyze the FMV model for determining DLOM on private equity, and b to determine whether it is possible to develop a statistically valid regression-based model to determine the DLOM.

FMV Opinions and its principals continue to heavily promote their two-step approach utilizing their database in contributions to various valuation publications and with presentations at various seminars and meetings. Thus, it is likely that we will continue to see this approach used by various practitioners. Copy is provided as an Exhibit to this job aid. These studies analyze identical stock of the same company and compare price points before the stock is publicly traded and at the point that a liquidity event such as an IPO occurs.

Various authors have performed studies using various measuring periods in an attempt to get a stable and reliable pre-IPO stock price for comparison to the price set for the IPO. These measurement points have ranged from several days prior to the IPO to several months prior to the IPO. Generally, pre-IPO results lead to discount choices higher than those implied by the restricted stock studies. Traditionally many valuators would consider the results of both the restricted stock studies and the pre-IPO studies, consider the summary statistics and then select a DLOM for use in some subjective matter based on all of these studies.

In more recent times, the pre-IPO studies have fallen somewhat from favor due to a significant number of problems identified in their use. The decision in McCord v. A recent court decision, Bergquist v. A pre-IPO study examines arm's-length sale transactions in the stock of a closely held company that has subsequently achieved a successful initial public offering of its stock. In a pre-IPO study, the DLOM is quantified by analyzing with various adjustments the difference between the public market price at which a stock was issued at the time of the IPO and the private market price at which a stock was sold prior to the IPO.

Three sets of such studies are identified and discussed below: o Willamette Management Associates o John Emory o Valuation Advisors D. Pre-IPO studies have also shown substantial dispersion of the discounts around their sample means Willamette Management Associates WMA : WMA performed a series of studies on the prices of private stock transactions relative to those of public offerings of stock of the same companies. The studies covered the years through See a summary of the studies in Exhibit B Exhibit B--Pre-IPO Studies.

The median discounts ranged from a low of Emory of Robert W. The studies covered various time periods from through The basic methodology employed in each of the eight studies was identical. The prospectuses of over 4, offerings were analyzed to determine the relationship between 1 the price at which forex trading hindi language 7 little words stock was initially offered to the public and 2 the price at which the latest private transaction occurred up to five months prior to the IPO.

See a summary in Exhibit B Exhibit B--Pre-IPO Studies. Valuation Advisors' Lack of Marketability Discount Study was developed put option valuation sample literature review Brian Pearson of Valuation Advisors, LLC VALand compares the initial public offering IPO stock price to pre-IPO common stock, common stock option and convertible preferred stock prices. These market based transactions demonstrate the lack of marketability discount afforded by the pre-IPO instruments because of their illiquidity when issued by a privately held company.

Summary In general, the Pre-IPO studies provide measures of central tendency for DLOM that are higher than those provided by the restricted stock studies. One must be cautious as to going too far back, however, because put option valuation sample literature review conditions in general and for the company in specific could have changed markedly over time, especially if the company is small and in a highly competitive industry. Private transactions studied were between 5 months and 3 years prior to the IPO, providing a strong argument that factors other than marketability alone led to the price increase.

What the Courts say about this approach There have been numerous court decisions where the Pre-IPO approach to DLOM was considered. Memo50 T. United States 53 Fed. Claims LEXIS 42 Fed. Commissione r T. The essence of this approach is that straight restricted stock analysis misses the true characterization of DLOM for private companies because it relies totally put option valuation sample literature review data relating to public companies, even though it focuses on the restricted stock of those companies.

Per its supporters, private companies are even less marketable than the restricted stock of public companies and thus an extra increment of discount is appropriate. The approach is relatively new and has not had any significant vetting in the practitioner community or by the courts. The DLOM is thus 15 Cost of Floatation of Registered IssuesWashington, DC: Securities and Exchange Commission, See also The Costs of Going Public, Jay R.

Ritter, Journal of Financial EconomicsVol. However, it does not reflect the risk associated with the uncertain holding periods that are typical for an illiquid investment in private equity and therefore, does not quantify the entire DLOM. It is also not applicable to minority interests which are the most frequent interests in question when a discount for lack of marketability is to be estimated.

The factors and the analysis that go with them have since been cited in several following court decisions and are considered by many valuators to form a good conceptual basis for thinking about and quantifying DLOM. The courts have emphasized, however, the process defined in Mandelbaum as opposed to the actual quantitative result that was achieved in that case. Summary: Per Judge Laro, the following factors should be addressed as they pertain to a discount for lack of marketability for the subject company.

If the subject shares do not have a publicly traded counterpart, review of the restricted stock studies can serve as an important reference. Financial Statement Analysis Financial statement analysis would include historical and projected trends in profitability, leverage, distributions, liquidity, and volatility of these and other measures. Nature of the Co. History, Position in Industry, Economic Outlook Investors gravitate to positive results and shy away from risk 5.

Amount of Control in Transferred Shares Control or related influence will typically be perceived as reducing risk 7. Restrictions on Transferability of Stock Specific clauses that are viewed as unattractive and tend to increase discounts: 16 Mandelbaum v. Memo D. Holding Period for Stock The key is whether such holding period is discretionary or mandated.

Restrictions on holding are clearly perceived as negative by investors. But for non-marketable securities, the loss of vital timing in being able to liquidate an investment can be regarded as a substantial negative to a prospective investor that is faced with an uncertain time horizon and outlook, including impacts of overall capital markets 9. Costs Associated with Making a Public Offering While public offerings are under the control of the corporation or majority owner, these provisions only related to marketability.

RulingCB D. Among the lessons learned are that: 1 Detailed data developed first hand by the testifying expert, as opposed to medians cited from studies performed by others, are required to sustain discount opinions 2 The courts recognize there are reasons to go above or below the medians, but they will do so only when presented with soundly reasoned and empirically supported arguments 3 One size discount should not apply to all 4 Blanket approaches using historical averages are not sustainable; a case-specific analysis is needed For example, in the Estate of Jelke v.

Memoreversed and remanded, F. Thus, the court followed a Mandelbaum process but did not blindly endorse the original Mandelbaum result. Securities-Based Approaches The security-based approaches to estimating the Discount for Lack of Marketability are based on theoretical option pricing models e. Longstaff, Chaffee and from observing illiquidity demonstrated by traded stock prices bidask- spread and option prices LEAPS.

Robert Trout originally published the LEAPS study in September 17 and Ronald Seamen updated the study in June 18September 19 and March A LEAP is a long-term put option with a term of approximately 1. An investor, therefore, can buy protection against stock price declines by purchasing a LEAP put option. The LEAP studies examined the cost of purchasing the LEAP puts.

The DLOM is then calculated as the cost of the put option divided by the stock price. The authors segmented the data by a safety rank measured by the Value Line Investment Survey with 1 representing the least risk and 5 representing the most risk. Summary: The authors concluded that the observed DLOM derived from the LEAPS studies should be viewed as a benchmark minimum price when applied to privately held companies.

They viewed the put option valuation sample literature review discounts as minimum price discounts since a. The market value of the companies offering the underlying securities was much larger than the value of a privately held company 17 Robert R. The underlying securities are marketable c. The LEAPS can be sold at any time during the holding period d. There is a known liquidity event for LEAPS e. One year median discounts ranged from 8.

Two year median discounts ranged from 9. A one year or two year implied discount would be used as a proxy depending on the length of time it would take to market the subject interest e. Therefore only the cost to purchase a put option is considered if using LEAPS data to develop a DLOM. If an investor can purchase a put Protective Put to protect against a downward movement in the stock the investor can also sell a call option Covered Call and receive a premium to offset the cost of the put.

As a result the overall cost is reduced since the investor is receiving a premium for selling the call. What the Courts say about this Approach include cite : This approach has not been vetted in any meaningful way by the courts. Longstaff authored a study that relies on stock option pricing theory to estimate the DLOM for a privately held company.

Essentially Longstaff assumed that an investor with perfect timing ability would have the ability to identify a point in time in which the security 24 Longstaff, Francis A. Essentially, at expiration, the holder can "look back" over the life of the option and exercise at a value based upon the optimal underlier value achieved during that period. Look backs can be structured as puts or calls and come in two basic forms: A fixed strike and a floating strike.

If an investor is locked up for a certain period of time the investor gives up the opportunity to sell the security at its maximum price. Sample Outputs from Longstaff Model Volatility of Underlying Stock 1 Day 0. Therefore, the model may produce results which are not realistic as indicated in the table below. Absent these restrictions, the investor would know the exact best forex trading brokers in london who are the beefeaters to exercise the option and sell the underlying stock and would do so.

It is more useful for estimating the discount on a large block of restricted stock of a publicly traded company. What the Courts say about this Approach: This approach has not been vetted in any meaningful way by the courts. Chaffee authored a study, which related the cost to purchase a European put option to the measurement of the Discount for Lack of Marketability. Summary In David Chaffee III published an article on his theory that the Black Scholes Option Pricing Model could be used to determine the DLOM.

He found that the European Option 26 exercisable only at expiration was an appropriate model for the SEC Rule Holding Period of restricted shares. Increasing the holding period to greater than four years did not materially change the DLOM. According to Chaffee the use of the Black Scholes Option Pricing model for European options produced a minimum DLOM since a European put option pricing formula does not take into account early exercise. American options can be exercised early.

Hitchner, Financial Valuation, 2 nd Edition John R. Wiley and Sons Other qualitative factors must be considered to determine a final DLOM. The option models provide a proxy for marketability and the model can't be used without consideration to other factors. What the Courts say about this Approach This approach has not been vetted in any meaningful way by the courts.

The illiquidity is measured as the percentage difference between the bid and the ask price. In most markets, there is a dealer or market maker who sets the bid-ask spread to cover its costs of holding inventory, processing orders and 28 Amihud, Yakov, and Mendelson, Haim. The spread has to be large enough for the dealer to cover his costs and yield a reasonable profit. Amihud and Mendelson tested market rates of return against yield spreads difference put option valuation sample literature review bid-ask price for various financial stocks for the period Their regression was significant.

This signifies that the returns on the stocks were not only a function of risk but also of illiquidity. Therefore, the riskier the stock, the larger the spread and the higher the implied DLOM Summary This is a conceptually simple approach and utilizes actual market data. Market makers are market savvy and could be inclined to over-estimate the implied DLOM to build a spread that will bring them increased profits.

The more traders that there are in the marketplace the better the bid-ask spread should represent the actual effects of lack of marketability. Analytical Approaches The analytical approach studies the discount for lack of marketability DLOM through the consideration of various transactional data sets. The involved data sets have been put together by the authors of the DLOM studies from various sources and number from less than to several hundred sale transactions involving stock sales conducted outside the public market place.

The sales normally involve the stock issuer as seller and various institutional entities as buyers thus by-passing the normal registration requirements of the U. Securities and Exchange Commission SEC for stock to be sold to the general public. These data sets generally compare the sale price for blocks of publicly traded stocks sold through private placements as compared to the sale price of the shares as traded on the primary market where such are listed.

These data sets are analyzed statistically and through regression analyses to both determine the total amount of the discount and the breakdown of that discount across various postulated causal factors. The transactions that make up the dataset are screened in various ways to eliminate outliers and to identify any specific factors relating to the private placement that are not comparable to the factors that are attributable to associated traded shares that also constitute minority interests.

Where significant size blocks are involved in comparison to normal daily trading volumes for the associated stock on the public marketplace, some aspect of blockage discount as well as regular DLOM may be present in the transaction. The valuation analyst needs to be alert to such a possibility. Almost all of these researchers come from the academic community and none started out his or her research with tax concerns in mind.

The research was undertaken for various purposes but the fundamental underlying intent was to better understand the characteristics of capital formation among public companies. Typical questions posed for study are when should debt be issued instead of stock, when should preferred equity be issued instead of common equity, when should common equity be issued instead of debt or preferred equity and what mode of issuance should be used. The third study is the Bajaj et al analysis that has been referred to in a number of court cases that have been tried since the year and the fourth study is a portion of a body of work by Ashok Abbott that has drawn recent attention to the area of discounts for lack of liquidity DLOL.

Lack of marketability LOM and lack of liquidity LOL have often been treated in the literature as identical concepts. However, these two areas have been distinguished by Pratt 30 and Abbott 31 as follows. Per Pratt, marketability is the legal ability to sell an asset whereas liquidity is the ability to sell an asset without delay and without loss of value. Liquidity, on the other hand, denotes the ability to convert an asset into cash without diminishing its value.

These terms are explained below. Evidence indicates that the per share price of a private placement transaction is often set at a discount to the publicly put option valuation sample literature review price of the same stock as quoted in the market. Such shares can be sold to specific sophisticated investors such as those noted above. In many cases, both registered and unregistered shares sell at a discount when privately placed in bulk.

If one assumes that a registered share is freely tradable to anyone at any time then a marketability discount of zero would pertain to that share. Thus, by comparing the total discount per share for the private placement of unregistered shares to that of registered shares, analysts can obtain an estimate of the discount for lack of marketability for those shares since all other discount factors should be the same. Some analysts dispute this approach on the grounds that even registered shares do not necessarily have a lack of marketability discount of zero if such are offered in bulk or are thinly traded in the marketplace.

Under this logic the difference between the price of unregistered shares and registered shares offered in private placements would tend to under-estimate the discount for lack of marketability. Primary Reviewed Studies a Karen Hopper Wruck 32 Background and Summary Karen Wruck studied equity ownership concentration and its effects on firm value. Her premise was that private placements act to increase ownership concentration by bringing aboard more large shareholders and that such increased concentration should manifest itself in an overall increase in firm value thereby benefiting all shareholders.

On the other hand, public offerings of equity tend to dilute share value for the existing ownership base. Wruck studied private sales of equity involving 65 companies traded on the New York Stock Exchange and 63 companies traded on the American Stock Exchange between July and December She measured the share price of the stock on the exchanges 1 day after the announcement of the private placement and compared that price to the share price involved in the placement. The median difference in discounts was Wruck concluded that private placements of all types sell at a discount to the publicly traded mustafa singapore forex company but that unregistered shares required a higher discount for placement than registered shares.

It was postulated that the need for this higher discount was a function of lack or marketability as well as the increased costs of monitoring borne by investors that hold unregistered shares. She hypothesized that private placements are generally bought by active investors that act to keep management on its toes thereby positively affecting overall firm value. Since monitoring costs are involved to some extent for private placement investors, whether their shares are registered or unregistered, users of the Wruck study have postulated that the However, since the Wruck analysis did not control for the effects of other potential contributing variables, it is quite possible that a meaningful portion of the average discount difference could be caused by existing operational differences in data set firms rather than to marketability.

Both registered and unregistered placements are considered with companies listed on two different exchanges represented almost equally. The sample of firms chosen seems to have been primarily based on data availability rather than logical selection methodologies. Of the firms in the sample, a determination was available for only 73 of the placements and that determination was subjective in nature.

This weakness is somewhat mitigated by the methodology that compares registered discounts to unregistered discounts instead of measuring unregistered discounts in total as an indication of lack of marketability. Thus, assuming that a market bounce might result from any private placement as Wruck hypothesizes, the difference in discount existing between the two types of placements might still be a valid measure of lack of marketability effects. View of the Valuation Community The Wruck study has been cited by a number of practitioners but is basically utilized as background material to introduce the subject of investigating marketability discounts analytically.

Although the average and median discounts of the study are offered as evidence that the results of the benchmark studies may be much too high, the Wruck discounts themselves are not offered as actual discount proposals. View of the Courts Since the numerical values of the Wruck discounts have not been advanced in court as actual discount amounts, the courts have not specifically opined on the Wruck study and its results. Due to the higher risk inherent in these types of firms, they tend to offer private placements priced at higher than normal discounts.

These higher than normal discounts compensate investors for the higher information costs incurred and the higher monitoring costs required to keep suitably informed of investment status. They considered this to be a surrogate for DLOM. However, they opined that this surrogate should not be accepted on face because they believed that if the DLOM discount was really this high, then firms would react by registering all of their shares prior to placement.

The time period of their study was January 1, through May 31, The measurement date used was 10 days after the announcement of the placement was made. Of the placements analyzed, 45 involved registered shares, 18 involved unregistered shares and 43 had an unknown registration status. A regression analysis was performed using 7 independent variables with the registered versus unregistered variable used to estimate DLOM.

The average private placement discount overall was found to be The remainder of the discount was due to such other factors as the size of the placement, the degree of financial distress existing in the firm and the nature of the placement buyers. This effect is measured at These smaller companies would seem to be more like the companies that are most often the subject of valuation assignments where lack of Apple Stores to Allow Broken iPhone Trade ins is a concern than are the larger companies studied by Wruck.

This is an obvious, very serious problem with the methodology employed since it is the registration status variable that is put forth as the measure of lack of how to profit from fibonacci retracements in forex trading made in the study. This choice should also act to produce a more conservative discount result; however, the choice of measurement point remains arbitrary and totally subjective.

Bajaj, Denis, Ferris and Sarin 36 Background and Summary Bajaj et al set about to study the concept of firm value and marketability discounts. They defined marketability as how quickly an asset can be converted into cash, without the owner incurring substantial transaction costs or having to give significant price concessions. They postulated that lack of marketability increases opportunity costs for asset holders and that such holders are also exposed to increased risks of loss.

Both of these factors increase risk and lead to the need for discounting to lure investors to buy. Bajaj et al set out the following factors affecting marketability: -Uncertainty of the assets value -Lack of availability of information on the asset to an outsider -Availability of close substitutes for the asset -Duration of the restriction on trades of the asset -Size of the block being sold 36 Bajaj, Mukesh, David J.

The measurement date used was 10 trading days after the announcement date. Accounting data was drawn from Compustat. A cross-sectional analysis of discounts was made using regression techniques. Bajaj et al found that, on average, all private placements are made at discounts whether the block placed consists of registered shares or non-registered shares. For registered shares, the average discount was The respective median put option valuation sample literature review were 9. Combining unregistered and registered share transactions gave an overall average discount of As a first estimate of DLOM the average discounts were compared to get a discount differential of This was predicated on the premise that no DLOM should exist for registered shares since such could become immediately freely traded.

A regression analysis was then conducted to attempt to further sort out the factors contributing to the overall discounts. The coefficient for the registration variable turned out to be 7. Bajaj et al also stratified their overall discount data to provide statistics for the larger group of discounts, the middle group of discounts and the smallest group of discounts. Discussion was provided of the various factors that might explain the range of differences among these stratified groups.

These included the fractional size of the block to total shares outstanding, the business risk facing the firm, the degree of financial distress of the firm and the total proceeds raised in the offering. The Bajaj et al study has generated considerable response and criticism as it was the first study offered as a basis for court testimony for tax purposes when Dr. Bajaj began testifying before the Tax Court in cases such as the Estate of Gross and McCord.

Most notable among the parties criticizing the study were Shannon Pratt, Mark Mitchell, Lance Hall and Chris Mercer. These critics found problems with many facets of the study including sample selection, measurement date, the combining of registered and unregistered share transactions, the choice of regression variables, the failure to consider the holding period as an explanatory factor, the failure to consider the Rule affiliate provisions, the failure to properly identify registration status, and lack of rigor in the regression model employed.

His put option valuation sample literature review discount amount of 7. Weaknesses The potential weaknesses of the Bajaj study have been spotlighted by a number of its critics including Pratt, Hall, Mercer and Mitchell and Norwalk. These weaknesses are concentrated in the areas of concern over sample choice, the remaining presence of some adam warner options trading 5 min in actual registration status, the relatively low coefficient of determination or R 2 factor 37 generated by the regression model used and the choice of a measurement date of 10 days after the announcement.

Bajaj himself has been somewhat inconsistent in how he applies the results of the study using the 7. Not all unregistered placements are subject to the same holding period ODT Download ninjatrader for mac and, accordingly, the analysis of registered versus unregistered placements should not be treated as a binary variable as Bajaj has proposed. If all the data were to fall directly on the model line then the coefficient would be 1.

The lower the coefficient the less of the variability of the data is explained by the model. Important Put option valuation sample literature review of the Study Bajaj combines the five areas potentially affecting marketability related discounts into four parameters for use in his model. Other important variables are the selection of the sample to be analyzed and the choice of the measurement point. The critics advance a number of reasons why the Bajaj approach should not be accepted by practitioners but, in each case, the criticism is accompanied by support for the critics own preferred approach to DLOM.

In the case of Pratt and Hall, this is the use of the benchmark study approach while in the case of Mercer it is the use of his QMDM approach. Hall believes that the data in the FMV Opinions restricted stock study can be used to counteract the conclusions that Bajaj has advanced. Altman, Financial Ratios, Discriminant Analysis and the Prediction of Corporate BankruptcyJ.

Fin The higher the Z-Score of a company, the stronger its financial position. Shapiro have gone to Court with the analytical approach as their main support for a DLOM discount selection. Bajaj has testified in the Estate of Gross 39Litman and Diener v. USA 40McCord et ux v. Commissioner 41 and Richie C. Commissioner 42 among others.

Shapiro utilized the same approach in his testimony in Lappo v. However, no Court has accepted his 7. This total discount was accepted by the Court. Abbott 44 Background and Summary Abbott studied empirical methods for estimating marketability and liquidity discounts. Liquidity is then seen as the ability to convert a block of securities into cash.

Per Abbott, marketability refers to a right and liquidity is a measure of speed. Abbott believes that neither the pre-IPO nor the Restricted Stock Studies give very usable results for a number of reasons. Among these are changes in the 39 Estate of GrossT. Memo78 T. RIATax Ct. Memo LEXIS 40 David S. The United StatesUnited States Court of Federal Claims, U.

Claims LEXISAugust 22, 41 McCord v. Memo 43 Clarisa W. MemoTax Ct. Memo LEXIS86 T. CCH 44 Ashok B. Per Abbott, recent law changes and market developments have made public markets more liquid but this change does not extend to private markets which could lead to an understatement of discounts appropriate to these markets. Hence, he believes that a more scientific and statistically supportable approach to marketability and liquidity is now required. He then analyzes a number of studies and discount indications that exist.

This review provides the following lack of liquidity indicators. These discounts are upper-bounds since Longstaff assumes perfect market timing in making his analyses. Strengths Abbott recognizes the differences between public and private markets and the importance of block size as considerations in the discount for lack of marketability. He further recognizes the effect of relatively new innovations in simple form input html options 12 The trimmed mean is the average obtained from a subset of the data after some of the largest and the smallest values have been removed.

It is thought to be a better measure of the central tendency of the concentrated core of the data than is the overall mean. Longstaff, How Much Can Marketability Affect Security Value? Fin,December D. Further, he recognizes the importance of overall company capitalization on the holding periods required to sell stocks. Abbott cautions as to the risks involved in using public stock-based discounts for stocks that are not publicly traded on any recognized exchanges.

His strengths are mostly conceptual rather than of a nature that would necessarily lead to a reliable numerical estimate for either DLOL or DLOM. It is doubtful that his work could serve as a primary approach to marketability quantification as of the present time. He has been invited to speak at numerous valuation conferences and to participate in a number of panel discussions such as the BVR Teleconferences. There has been no use of the results that he has generated as a basis for discounts that would properly serve as a foundation for an overall valuation.

View of the Courts The Abbott analyses and findings have had no vetting in the courts. Conclusion Overall, many judges seem to be using the work of Bajaj and the other analytical studies as ammunition to hold all practitioners accountable for unsupported reliance on the benchmark studies. Even though an acceptable bottom line number has not come out of these studies per se, they have raised several questions and have tended to show that the benchmark studies can sometimes lead to unreasonably high results.

Among the questions that they have brought to D. Put option valuation sample literature review a result of the weaknesses cited relating to sample selection, sample point classification and measurement point concerns, it is unlikely that these approaches can be used to derive a numerical result that will go forth unchallenged. Instead, the raw data collected and the many component factors proposed can be used to make subjective put option valuation sample literature review about discount magnitudes that would seem more satisfactory than using the gross averages generated by the benchmark studies, either with or without unsupportable adjustments for changing facts and circumstances.

For example, consideration of volatility and expected holding period as opposed to restriction period would seem to be factors that provide meaningful insight to the DLOM and DLOL question. Also the availability of hedging strategies can act to increase effective liquidity where those strategies exist. These strategies replicate the existing value parameters of a non-liquid security by combining the value parameters of other securities that are publicly traded and, therefore, more liquid.

Christopher Mercer, ASA, CFA, Peabody Publishing, LP The model calculates a matrix of discounts for lack of marketability, based upon a range of variables. Variables include rate of appreciation in assets, holding period until liquidation, and required rate of return to the hypothetical investor. The appraiser estimates which variables from the matrix are most appropriate for the subject interest. The intersection of those variables within the calculation matrix yields the DLOM.

Given the variable inputs, discounts from this method can vary significantly. Important Parameters for this Approach 1 Base value of the marketable minority interest the base value would be the pro rata of the subject interest, after the discount for lack of control, but before the discount for lack of marketability ; 2 Expected appreciation on base value over the holding period; 3 Expected dividend yield over the holding period; 4 Expected growth rate in dividends over the holding period; 5 Assumed length of the holding period in years; and 6 Required rate of return to hypothetical investor over the holding period Variations of the QMDM can incorporate additional factors, such as interim cash flows, compensation to officers including over-compensationtaxes, etc.

However, the model can become very complicated with the introduction of additional variables. Prevalence in professional practice: This approach has seen minimal use by outside valuation professionals as the primary basis for the DLOM. He further stated that, despite some Court rulings involving the QMDM approach, he and his firm has not been rebutted in Court for using the QMDM.

View of the Courts Prior to the QMDM, the Courts had criticized appraisers for a lack of quantitative basis for their DLOM determination e. The QMDM appeared to be an answer, but Weinberg v. In each of these cases, the QMDM was criticized: Weinberg v. Kursh on the basis of the QMDM model because slight variations in the assumptions used in the model produce dramatic differences in the results.

NICE is a valuation system under the income approach designed to determine the fair market value of equity interests in closely held investment entities. NICE uses investment returns to calculate value. According to the article in Valuation Put option valuation sample literature review see above for citation reference : [NICE] is a valuation system under the income approach to value. It is designed specifically to determine the fair market value of put option valuation sample literature review interests in closely held investment entities, such as family limited partnerships, S corporations, and limited liability companies.

NICE does not use [lack of control and lack of marketability] discounts in its operation. Instead, lack of control and lack of marketability are viewed as investment risks embodied in the required rate of return for the subject interest. Such estimates can begin to appear subjective, depending on the availability of adequate information.

Given the variable inputs, discounts from this method can vary. The NICE method specifically states that it should not be used when the holding period is either known or can be reasonably estimated. This incremental return is illustrated on the basis of above-average performance of certain mutual funds. However, the article admits that mutual funds generally cannot maintain above-average performance indefinitely.

Prevalence in Professional Practice: The NICE or Frazier method has not been seen in valuation reports we have reviewed. If presented to a Court it is likely that the Court will criticize this method as relying upon subjectively-estimated incremental rates of return for lack of control and lack of marketability unless some definitive market evidence were provided in support of these rates. According to the NERA website www.

Tabak provides a review and analysis of existing studies and theories on calculating appropriate illiquidity discounts for restricted stock. Tabak discusses how existing studies have limited applicability in calculating an appropriate discount because they generally present only median or average results. As an alternative, Dr. Tabak offers a theoretical model based on the CAPM, or capital asset pricing model, that allows for a quantification of the illiquidity discount based on objective criteria specific to the asset under consideration.

This equity risk premium-based model is the first approach to apply the CAPM to the process of calculating illiquidity discounts, and offers a number of benefits over using simple average discounts or any of the other methodologies discussed in this paper. The result is a framework for measuring illiquidity discounts that vary over time and depend on the length of the restriction and the riskiness of the illiquid asset.

Perhaps most importantly, Dr. Tabak's new model is less subjective than the analysis often used in practice today. The table indicates a full dataset range of discounts from Briefly defined: Beta is a factor indicating the relative risk of a specific investment, as compared to overall risk attributable to the aggregate market of investments. NOTE: While some methods compare overall rates of return [e.

Important Parameters for this Approach According to the working paper, the model requires data or estimates of: 1 risk-free rate of return; 2 expected return to a market portfolio; 3 expected return to the subject asset; 4 covariance of the subject asset with respect to the market portfolio; 5 standard deviation of rates of returns; and 6 period of time that the asset is restricted from sale.

Of particular significance to the use of this method, the working paper see above for citation reference states: To begin, assume that these quantities are all measurable This suggests from Dr. Tabak himself that there are inherent weaknesses in the method. Prevalence in Professional Practice: We have not seen the NERA or Tabak methods, per se. What the Courts say about this model: No Court references were found for the NERA or Tabak method.

Data for each re-sale includes a pro rata net asset value attributable to each RELP interest being sold. Partnership Profiles is primarily used as the basis for lack of control discounts on minority limited partnership interests. However, the RELP re-sale market is so small i. With respect to lack of marketability, Direct Investments Spectrum has stated: Although it is not possible to precisely quantify the amount of discount attributable to marketability versus lack of control considerations, it is the opinion of Direct Investments Spectrum, along with many appraisers, that most of the overall discount is due to lack of control issues.

These factors provide specific bases to identify comparables within the data. On that basis, Partnership Profiles might reflect out-offavor investments, being sold under distressed conditions at high discounts to net asset value. Important Parameters for this Approach 1 Types of underlying investments e. Prevalence in Professional Practice Partnership Profiles data are primarily used to estimate lack of control discounts on minority limited partnership interests.

In most cases, the appraiser would use Partnership Profiles to estimate the lack of control discount, and then use another method such as restricted stock studies to estimate a separate DLOM. However, because of the nature of the data, some appraisers use Partnership Profiles to estimate a single combined discount for lack of control and lack of marketability. In cases of charitable contributions e. What the Courts say about this Approach: In Estate of W. In Estate of Kelly v. On that basis, public company sellers negotiated higher relative purchase prices because their shares were marketable, and could be sold elsewhere if necessary.

However, private company sellers could not easily sell their shares elsewhere. Thus, they negotiated lower relative purchase prices because their shares lacked marketability. The median has not followed any single trend in prior years. A review of the MergerStat data will indicate how the median has trended in the years leading up to any specific valuation date.

Therefore, reliance upon these data for analyzing lack of marketability on a D. Summary median figures can obscure significant variance in underlying data. However, this method can provide additional support for an overall analysis of the DLOM that incorporates one or more additional methods of estimating the DLOM in a given appraisal. Prevalence in professional practice The use of Mergerstat for DLOM has been seen a few times, but generally only as additional support for an overall DLOM analysis that used additional methods of estimating the DLOM.

One possible explanation for its infrequency of use is that MergerStat Review is so commonly cited as the source of data for lack of control discounts. Another citation of MergerStat Review in the DLOM area of the valuation analysis might be confusing to the reader. What the Courts say about this model No Court references were found regarding the use of MergerStat specific to estimating the discount for lack of marketability there are Court rulings where MergerStat was used for the discount for lack of control.

Evaluation and Recommendations DLOM Job Aid page 68 E. Evaluation and Recommendations 1. Approaching Marketability Discount as a Reviewer In considering the discount for lack of marketability as a reviewer, you will be presented with an approach and be concerned with judging its reasonableness, its reliability, its adherence to the prevailing facts and circumstances of the valuation problem at hand, its general acceptance within the valuation community and the treatment that the approach has received at the hands of the Courts.

These arguments will need to be considered in detail and judged upon their merits. If the taxpayer or the appraiser has not offered any real analysis but rather simply presented a numerical result without substantial backup that does not automatically make the result achieved wrong or unsustainable. You will need to analyze the result in the light of the prevailing facts and circumstances to determine whether it is reasonable or unreasonable. If the result is considered unreasonable as a result of your review, you will likely be called upon by the client to produce an alternative independent estimate of DLOM based on your own analysis of the valuation problem.

Your estimate should be constructed so as to not exhibit the same weaknesses found in the appraisal being reviewed. If the taxpayer or appraiser has used a valid approach or approaches but reached an unreasonable result you may be able to simply discuss what makes that result unreasonable and why you believe that your analysis yields a more reasonable result.

If the taxpayer or appraiser has not used a valid approach in your view then you will have to start from scratch in preparing your opinion. Approach Marketability Discount as a Valuator If you are approaching the question of DLOM fresh, either as a reviewer confronted with an unreasonable taxpayer position based on invalid approaches or as a valuator charged with making your own valuation discount decisions, it is often helpful to start with a basic question as relates to DLOM.

This process will give you a reality check on DLOM amounts that you might ultimately derive using some of the approaches discussed in this job aid. On the other hand, if you have a somewhat larger interest in a non-publicly traded entity that has a relatively large and active shareholder base with no restrictive shareholder agreement and where the potential seller holds a put right back to the corporation at fair market value then very little DLOM might be reasonable.

A common mistake among valuators considering DLOM and discounts for minority interests is to concentrate almost exclusively on the viewpoint of the hypothetical buyer who will be pushing at all forex calendar holiday 2012 rose for larger discounts while ignoring the viewpoint of the hypothetical seller. In proposing a DLOM amount the valuator needs to ask whether this is an amount that a hypothetical seller could accept under the prevailing facts and circumstances and whether there is a reasonable chance that an arms-length negotiation put option valuation sample literature review buyer and seller could arrive at such a discount amount.

A fair market value determination requires the consummation of a hypothetical sale. If the analysis relies too heavily on the needs of the buyer it is likely that no such sale would occur and that this underlying premise of fair market value would be violated. What follows is sample report language to use when these situations are encountered: a Use of Pre-IPO studies to support DLOM b Use of simple average or median from Restricted Stock Studies c Use of analytical study results without getting behind the data d Use of study results not supported by market data e Reliance solely on court decisions a Up and out put option formula units of Pre-IPO studies to support DLOM The pre-IPO studies cited Emory, Willamette or Valuation Advisors examine the difference between pre-IPO stock transactions and their IPO price.

When companies register metatrader report letter an IPO, they are required to disclose all transactions within three years prior to the offering. The pre-IPO studies observe transactions in privately-held companies that eventually completed an IPO. The private transaction price was compared to the public offering price, and the percentage discount from the public offering price is considered a proxy for the discount for lack of marketability.

Such an event would minimize any discount for marketability. The restricted shares were generally sold in private placements, or similar transactions, under conditions which prevented them from being re-sold for some period of time generally two years for put option valuation sample literature review SEC Study.

SEC Study Table 1 Table 1 Analysis of SEC Institutional Investors Restricted Stock Study presents detailed data from the SEC Study. According to the source reference, 48 The restriction period has generally decreased from two years to one year for similar transactions occurring after the year However, significant variance in implied discounts for lack of marketability throughout the dataset suggests that factors, other than exclusively marketability, contributed to observed price differences between restricted and unrestricted shares of stock.

Management Planning Study Table 2 Table 2 Analysis of MPI Restricted Stock Study presents detailed data from the Management Planning Study, which also analyzed discounts on sales of restricted stock. According to the source reference, these data are more recent than the SEC Study, and reflect 49 transactions over the years through Evaluation and Recommendations DLOM Job Aid page 72 each grouping do not follow this trend.

Instead, the lowest discounts observed within the entire range 2. Data in Table 2 are presented in regards to the issue of lack of marketability. However, significant variance in implied discounts for lack of marketability throughout the dataset including lack of trend for lowest discounts within each grouping suggests that factors, other than exclusively marketability, contributed to observed price differences between restricted and unrestricted shares of stock.

Other factors Restricted stock studies have been criticized as being inconsistent with the Fair Market Value standard. All else equal, the buyer in this example might demand a below-market price to offset risks of investing in a company that was having difficulty raising additional capital. While the seller the company might demand restrictions on the new below-market shares to protect existing shareholders from a potential drop in stock price. Evaluation and Recommendations DLOM Job Aid page 73 Put option valuation sample literature review of this example transaction might then ask themselves Were the shares priced below-market because they were restricted?

Or were the shares restricted because they were priced below-market? On excluding other factors In regards to excluding other factors, the Bajaj Study 50 explored separation of lack of marketability from other factors believed to affect observed price differences between sales of restricted and unrestricted shares of stock. The following citation from the Bajaj Study suggests a 7. Summary An appropriate discount for lack of marketability should not overstate the effects of marketability upon the otherwise determinable pro rata value.

The appraiser should use judgment when applying discounts derived from summary median or average data sources to a specific company or subject interest. For example, a statement may be made that Wruck found a discount for lack of marketability of Evaluation and Recommendations DLOM Job Aid page 74 assignment or to justify a discount already determined by some other method.

Sometimes, one of these figures is simply adopted as representing the appropriate discount for lack of marketability in a given assignment. It should be remembered that these figures are the result of statistical analysis of a specific data set as chosen by the researcher. The data set in question contains those transactions chosen for one reason or another by the selector and is pertinent to a given time period.

Further, the selection methodology was not well documented and, in each case, relied upon certain assumptions as to registration status and appropriate measurement date. Finally, these studies were all conducted for academic purposes rather than tax purposes investigating various facets of capital formation and shareholder behavior. Although Bajaj eventually extended his study for tax use in his Tax Court testimony it was not originally intended for that purpose.

A valuator should not use the results from any of the analytical studies without getting behind the data that was used in the various analyses. With respect to Bajaj this is what the Tax Court attempted to do in McCord. Rather than accepting the 7. The Court justified its approach by noting that the transactions in this middle group most put option valuation sample literature review represented the transaction with which it was confronted in the Mc Cord case.

In so doing the judge distinguish the present valuation problem from the postulated circumstances attendant to both the highest and the lowest discount groups from the Bajaj study. Having put in chosen parameter values, the model then put option valuation sample literature review out a percentage loss in value or a reduced value that can be used to calculate a percentage discount for shortcomings in liquidity or marketability. Although the model may seem conceptually sound in the abstract, there is no attempt to validate the model using actual current market data.

For this reason, there is no way for the reviewer to perform a reality check on the model results. Examples of this approach may involve the application of the Quantitative Marketability Discount Model, one of E. Evaluation and Recommendations DLOM Job Aid page 75 the models based on option theory or one of the analytical approaches based on a limited data set. The discount for lack of marketability must be firmly based on current market evidence. This point was brought out clearly in the recent summit on DLOM held in San Diego and organized by Judge David Laro and Mel Abraham.

No matter how conceptually sound a model may appear to be, unless it can be demonstrated that it produces results that can be verified with market evidence, it remains a theoretical construct that assumes a negotiation pattern between willing buyers and sellers rather than being based on the results of such a pattern. A valuator must remember that a discount for lack of marketability or for anything else is but a step towards arriving at fair market value.

Thus, without a verifiable basis in the market, the valuator is asking the audience to take his result on faith based on what sounds reasonable rather than on what has been empirically demonstrated. For example, the valuator will review the results of several cases such as McCord, Lappo and Peracchio and then base the choice of discount on the discounts accepted by the court in the reviewed cases. Judges are sometimes found to adopt this approach as well.

It must be remembered that judges are not valuators and are not constrained to the environment in which professional valuators operate. A judge can adopt any approach that is considered useful and can arrive at any result that seems reasonable in his or her view based on all the considerations of the case which often go well beyond the discount for lack of marketability.

In addition, a judge will often select one discount over another simply based on the ability or lack thereof that the two sides of the dispute display in arguing their respective cases. The court is a trier of fact and need not, if that is its choice, go beyond what is presented to it. If one side argues persuasively while the other side disappoints the court for one reason or another a discount may emerge without any real justification for why it has been chosen. In fact, the discount selection may not be based on any clear valuation logic at all.

The courts are an excellent source of information when legal precedent is in question but can be a very questionable source when valuation guidance is desired. If the decisions from various court deliberations are to be utilized in the Next Page. August 16, - With increased interest in the IRS DLOM Training AidI have inserted my original source document here for ease of reading, and preservation of tables, graphs, etc. Discount for Lack of Marketability.

Job Aid for IRS Valuation Professionals. Mike Gregory, ASA, AVA. Engineering Territory Manager Issue Champion. Sue Kurzweil, CPA, ASA. National Business Valuation Issue Coordinator Project Manager. Jeff Myers, ASA, AVA. Engineering Team Manager Team Member. Financial Analyst Team Member. Aberdeen Sabo, Estate Tax Attorney Advisor. This job aid is meant to provide information to IRS Valuation Analysts when. E, Evaluation and Recommendations, in conjunction with Section D, Summary of.

Note that while certain of the studies reviewed may. The Valuation Put option valuation sample literature review must have a clear understanding of the. In other words, the Analyst must get behind the data used. The job aid does not make any bright line selections or exclusions as to what. Valuation Analyst's professional judgment. The DLOM Team would like to extend their thanks to the following IRS valuation. Monty Careswell, CPA, ASA, CVA TeamDenver, CO. Paul Elkins, CPA, CVA TeamKing of Prussia, PA.

James Peacock, AVA TeamAustin, TX. Terry Savill, AVA TeamFort Worth, TX. Also like to thank Counsel reviewers as coordinated through Steve Blum, and. Engineer Manager Jack Jolly who handled the design and upload to the intranet. B ENCHMARK A PPROACHES S ECURITIES -B ASED A PPROACHES A NALYTICAL A PPROACHES Hertzel and Smith Bajaj, Denis, Ferris and Sarin O THER A PPROACHES S OURCES AVAILABLE TO IRS V ALUATION A NALYSTS T ABLE 2 A NALYSIS OF MPI R ESTRICTED S TOCK S TUDY Access to studies and articles:.

The DLOM Team has attempted to provide access to most of the DLOM studies. For those who do not have access, please. If needed, contact a DLOM Team. DLOM Job Aid page 1. In June a team was formed for the purpose of exploring and developing. Size Business LMSB Engineering Program in dealing with the Discount for Lack. Lack of Marketability, exploration of the state of the art in estimating this.

Background: Initially, the team was charged with assisting Howard Lewis. Engineering Program Manager, who had been asked to act as a moderator for a. At the end of August. In October LMSB Field Specialists. The development work of this. Mike Gregory, Engineering Territory. Manager, was asked by Howard Lewis to initiate this process on behalf of the. Mike Gregory championed the work of the team and Sue. Kurzweil, National Engineering Business Valuation Team Lead from.

Independence, Ohio was selected as the Project Manager. Objective: The team researched the state of art in DLOM starting by defining. DLOM and differentiating it from such put option valuation sample literature review areas as Discount for Lack of. Liquidity DLOL and Discount for Lack of Control DLOC. We explored the models in recent. As a result of this initial work, the team developed.

Our hope was to provide a quality, timely. However, it is also recognized that many of the aspects of this issue have been. DLOM Job Aid page 2. Business and Self-Employed SBSE division are key players in the need for this. Annually, Estate Tax Attorney Christopher Bird compiles a listing of key. His willingness to provide a current summary analysis on. The information provided in this document is thought to address issues on the.

Any model or estimating technique can be. The commentary that follows addresses various. Further updates and changes to these models or techniques. Conclusion: This Job Aid is meant to provide a background and context for the. Discount for Lack of Marketability as such is commonly applied in business. It reviews past and existing practices and. It is not meant to provide a cookbook approach to evaluating a marketability.

We do not mean to provide guidance as to. DLOM Job Aid page 3. The application of the Discount for Lack of Marketability DLOM can result in a. Frequently, this discount is the subject of controversy in IRS valuation. These studies, methods and models can be. The business valuation profession does not identify. Research in DLOM continues for improved. Some of this research is published primarily as an.

The purpose of this job aid is to assist IRS valuation analysts in their examination. First, we will identify the current. We will identify the. The job aid also. The DLOM Team formed to consider discounts for lack of marketability includes:. Analyst Engineer Plantation, FL. Analyst Financial Analyst New York, NY. Analyst Financial Analyst San Francisco, CA. Aberdeen Sabo Advisor Estate Tax Attorney Independence, OH.

DLOM Job Aid page 4. While the team worked together on this project, members developed specific. Access is limited to those who have been granted. DLOM Job Aid page 5. General Marketability Discount Information. Marketability is defined in the International Glossary of Put option valuation sample literature review Valuation Terms. Given two identical business interests, a higher price will be paid by investors in.

An example is publicly-traded stock on the New York. Stock Exchange, where the owner can order the sale and the proceeds are. In the alternative, a lesser price is expected for the business interest that cannot. A primary concern driving this price. Accordingly, a prudent buyer would want a discount for acquiring such. What to remember about DLOM:. Liquidity is the ability to quickly convert property to cash or pay.

Certified Public Accountants, American Society of Appraisers, Canadian Institute of Chartered Business. Valuators, National Association of Certified Valuation Analysts, and The Institute of Business Appraisers. Niculita, Valuing a Business, The Analysis and Appraisal of Closely Held. Businesses5 th ed New York: McGraw Hill,p.

DLOM Job Aid page 6. Said another way, Liquidity is the ability to readily convert an asset, business. Compare Liquidity to the definition of Marketability: the capability and. A Discount for Lack of Liquidity DLOL is an amount or percentage deducted. These terms are often used. We define liquidity here because some of the studies or methods discussed in. Factors Influencing Marketability Identified. Factors that can have an influence on marketability are numerous. Mandelbaum Factors were set out in Mandelbaum v.

Some common factors that have been identified in various studies as impacting. DLOM Job Aid page 7. In Mandelbaumthe landmark case for marketability, Judge Laro set out various. Ascertaining the appropriate discount for limited marketability is a. Critical to this determination is an. DLOM Job Aid page 8. Mandelbaum, refer to the Benchmark studies at D. Calculate lot size forex trading meaning Factors, Judge Laro, However, common sense and the courts have emphasized that.

In considering the market for a subject. The courts have determined. CIR11 BTAthe court stated "we do not. DLOM Job Aid page 9. We further believe that a. There is little dispute that minority interests in non-publicly traded entities lose. However, the issue of applying a discount for. Some believe that there should be little or no discount for lack of.

Most agree that any marketability discount for a controlling. The controlling interest owner will be able to sell his or her business interest in. As Pratt discusses in. Valuing a Business, the following factors will have to be considered:. Because of these considerations, the controlling interest owner may not be able.

Among valuators who apply DLOM to controlling interests, it is generally agreed. Court cases where DLOM was considered and allowed on a controlling interest:. DLOM Job Aid page Sample Initial IDR Items on Marketability. The evaluation of the appropriateness of a discount for lack of marketability. We provide below a list of typical inquiry areas that can be put option valuation sample literature review.

The bracketed notes below each item offer trading bonus issue about that. Salaries and bonuses paid to the Officers of the company, over the five. List of all marketable securities description, number, cost value shown. List of all non-marketable securities and investments description, number. Breakdown of adjusted cost basis for each of the marketable and Nonmarketable. Section or similar type tax-deferred exchange [can provide.

Company articles of incorporation and amendments, by-laws and. All documents pertaining to any sale of the company, a division or unit of. Board of Directors Meeting Minutes, for five years leading up to valuation. Complete financial statements of the company for the five fiscal or. Complete income tax returns for the five fiscal or calendar years prior to. Summary of Approaches to DLOM. There have been numerous approaches taken by researchers and practitioners.

For discussion purposes, we have classified these. There are then certain. Restricted stock 9 has been used over many years by members of the. The restricted stock studies have been cited and analyzed in. Because the holder of restricted common stock is prohibited from selling any of the stock. Under SEC rules this restriction period deep out of the money put option volatility been either.

Many different researchers have collected data on restricted stocks and. The studies conducted have included various time periods for. In recent years, as the discipline of business valuation has continued to. Restricted stock studies are published, empirical studies, the most often. These studies analyze market data. SEC restricted stock rules prior to required investors to hold such.

Each of the reviewed. National Shared folder for information on mapping the network drive to. Attempting to Measure the Marketability. Discount for Private Firms. Journal of TaxationJune JournalJuly-August ReviewDecember,pp. Studies After 'No Longer Relevant' for Lack of Marketability Discounts", SHANNON PRATT'S BUSINESS. As can be seen from this data, the measures of central tendencies for.

This is a wide range in. Further, the sample sizes in these. This factor emphasizes the need to get into the data itself. One explanation for this phenomenon is the increase in. Commission SEC Rule a in the past several years. SEC under Rule from two years to only one year-took place as. Considerable raw data was available for. The most compelling criticism of existing studies is that they rely on.

A discount for lack of marketability is. With some of the data in the studies. It is imperative that the expected holding period of the subject. All except the last two studies use market data. The SEC, effective Aprilamended Section. The current law, effective. Februarynow requires only a six month holding period by. Using measures of central tendency without an examination of the.

The parameters underlying the studies vary by study; some key. Prevalence in Professional Practice. What the Courts say about this Approach:. Courts rejected the use of put option valuation sample literature review average restricted stock study results in. S, No CV March 10, Paraphrasing: while restricted stock data is helpful in determining a. NOTE: IRS Estate and Gift Tax Program webpage offers.

This resource can be accessed at:. Two components to restricted stock study data: a market access. The holding period component deals with the. SEC Rule required holding period for a restricted stock sale. Holman concluded that the hypothetical purchaser would demand. The FMV Restricted Stock database of transactions is available for purchase. IRS Engineer, Tom Kelley, AVA, completed an analysis 10 of the The purpose was a.

The conclusions drawn are:. FMV Opinions and its principals continue to heavily promote their two-step. Thus, it is likely that. Please refer to the Exhibits in this job aid for information on the process Tom. The pre-IPO studies are the second large group of studies within the. These studies analyze identical stock of. Various authors have performed studies using various measuring periods.

These measurement points have. The pre-IPO studies have derived measures of central tendency for. Generally, pre-IPO results lead to. Traditionally many valuators would consider the results of both the. In more recent times, the pre-IPO studies have. TNThas potentially breathed some life back into the pre-IPO. A pre-IPO study examines arm's-length sale transactions in the stock of a. In a pre-IPO study, the DLOM is quantified by.

Studies have shown average discounts of the pre-IPO price from the. Pre-IPO studies have also shown. Willamette Management Associates WMA : WMA performed a series. The studies covered the. See a summary of the studies in Exhibit B. The median discounts ranged from a low of. Valuation Advisors' Lack of Marketability Discount Study was. Emory, "Discounts for Lack of Marketability, Emory Pre-IPO Discount Studies as.

In general, the Pre-IPO studies provide measures of central tendency for. DLOM that are higher than those provided by the restricted stock studies. A difficulty in conducting and analyzing these studies is in determining the. One must be cautious as to going too far back, however. Private transactions studied were between. Studies and data may be skewed due to the dot. Important parameters for this approach.

Prevalence in professional practice. Not as common in practice as Restricted Stock studies after McCord case. What the Courts say about this approach. There have been numerous court decisions where the Pre-IPO approach. Among these are the following:. No dissent regarding rejection. This approach is a recent attempt to refine the traditional restricted stock. It derives a proposed. This approach to DLOM is fully described in a number of papers authored.

The essence of this approach is that straight restricted stock analysis. Per its supporters, private. Conceptually the approach proceeds as follows:. SEC dribble out rule. This approach is treated in more detail in Exhibit A to this job aid including. Analysts JournalJuly-Augustpp. The approach is relatively new and has not had any significant vetting in. The flotation cost approach quantifies the discount for lack of marketability.

The DLOM is thus. Ritter, Journal of Financial Economics. The approach is easily applied and a wealth of data is available. It is also not applicable to minority. The Mandelbaum Factors were set out in a Tax Court case 16 of the same. Benchmark Studies for the specific facts and circumstances of the. The factors and the analysis. Per Judge Laro, the following factors should be addressed as they pertain. In the event that a company has observable transactions between.

Financial statement analysis would include historical and projected. Investors in non-marketability securities prefer distributions as they. History, Position in Industry, Economic. Investors gravitate to positive results and shy away from risk. Intangibles such as management contribute to operational and. Amount of Control in Transferred Shares. Control or related influence will typically be perceived as reducing.

Restrictions on Transferability of Stock. Specific clauses that are viewed as unattractive and tend to. These provisions are onerous as they impair an. Holding Period for Stock. The key is whether such holding period is discretionary or. Restrictions on holding are clearly perceived as. But for non-marketable securities, the loss of. Put rights or expectations of near term monetization events reduce. Costs Associated with Making a Public Offering.

While public offerings are under the control of the corporation or. RulingCB What the Courts say about this Approach. The Mandelbaum approach has received a considerable amount of. For example, in the Estate of Jelke v. Thus, the court followed a Mandelbaum process but did not. The security-based approaches to estimating the Discount for Lack of. Marketability are based on theoretical option pricing models e. Chaffee and from observing illiquidity demonstrated by traded stock prices bidask.

Trout,and Ronald Seaman, Robert Trout originally published the LEAPS study in September 17 and. Ronald Seamen updated the study in June 18September 19 and March. An investor, therefore, can buy protection against stock price declines by. The LEAP studies examined the cost of. The DLOM is then calculated as the cost of the put. The authors segmented the data by a safety. The authors concluded that the observed DLOM derived from the LEAPS studies.

They viewed the derived hotforex currenex or premium account # 000046535 as minimum price discounts since. The market value of the companies offering the underlying securities was. The underlying securities are marketable. The LEAPS can be sold at any time during the holding period.

A one year or two year implied. One area in which there has been criticism of using the LEAPS data as a starting. Put option valuation sample literature review an investor can purchase a put Protective Put to protect against a. Covered Call and receive a premium to offset the cost of the put. As a result the. Purchasing a put option and selling a call on the underlying stock is called a.

At issue here is whether an investor in a privately held company, if they had the. LEAPS study than are considered in the restricted stock studies thereby. Theoretical Models to Estimate the Discount for Lack of Marketabilityby Travis R. Important Parameters for this Approach:. Prevalence in Professional Practice:. Not seen very often, particularly for closely held companies. What the Courts say about this Approach include cite :.

This approach has not been vetted in any meaningful way by the courts. Longstaff authored a study that relies on stock option pricing theory to. The Longstaff study is based. Using option-pricing theory the model. Essentially Longstaff assumed that an investor with perfect. Essentially, at expiration, the holder can "look. Look backs can be structured as puts or calls and come in two basic forms: A fixed. If an investor is locked up for a certain period.

Sample Outputs from Longstaff Model. Volatility of Underlying Stock. It should be noted that the above table is for illustrative purposes only and the. Volatilities in excess of. Therefore, the model may produce. Longstaff Model Discounts as a function of Time and Volatility. The Longstaff approach assumes perfect market timing and, therefore, derives. Absent these restrictions, the investor would. Most small cap companies have volatilities.

The model is not seen often for estimating DLOM for a privately held company. In David B. Chaffee authored a study, which related the cost to purchase. In David Chaffee III published an article on his theory that the Black. Scholes Option Pricing Model could be used to determine the DLOM. Chaffee relied on the Black Scholes Option Pricing Model for a put option to. The cost of the put option divided by.

Chaffee determined how to trade forex free jewel proxy of a Discount for Lack of Marketability based on. The appropriate DLOM for a stock with a two-year holding period and a volatility. Chaffee increased the holding period to 4 years, which showed a range of DLOM. Increasing the holding period to greater than four years did not. According to Chaffee the use of the Black Scholes Option Pricing model for.

European options produced a minimum DLOM since a European put option. European put option Black Scholes Formula. Other qualitative factors must be. The option models provide a proxy for. Important Parameters for this Approach. The stock price and exercise. Not seen very often, particularly in valuations of private companies. The bid-ask spread is the difference between the price asked for the business by. The illiquidity is measured as the percentage difference between the bid.

In put option valuation sample literature review markets, there is a dealer or market maker who sets. The spread has to be large enough for the. This signifies that the returns on the stocks were not only a function of. Therefore, the riskier the stock, the larger the spread. This is a conceptually simple approach and utilizes actual market data. DLOM to build a spread that will bring them increased profits. Other factors such as.

This approach is not seen very often for estimating DLOM for a privately held. The analytical approach studies the discount for lack of marketability DLOM. Securities and Exchange Commission SEC for stock to be sold to the general. These data sets generally compare the sale price for blocks of publicly. The types of data in question are similar to. The transactions that make up the dataset are screened in various ways to.

Where significant size blocks are involved in comparison to normal daily trading.




Call Option As A Derivative (Intrinsic Value, Time Value, Unrealized Holding Gains & Losses)


Report of the Highway Review Committee (HRC), which was established to undertake a technical review of the Debe to Mon Desir segment of the extension to the Sir. (Text Version Below) Discount for Lack of Marketability. Job Aid for IRS Valuation Professionals. September 25, Developed by Engineering/ Valuation Program. A; B; C; D; E; F; G; H; I; K; L; M; P; R; S; ACCOUNTING COURSE DESCRIPTIONS. ACC Financial Statement Analysis. An overview of the pertinent.