The Portable MBA in Finance and Accounting, 3rd Edition

Business Valuation 621

for fundamental differences between the selected public companies and the
private business. Thus, if these analysts first adjust the price multiple down-
ward as a fundamental adjustment and then apply an upward control premium,
the result may be similar to Victoria’s valuation conclusion.)
However, since the $35.2 million value is based on freely traded mar-
ketable securities, Victoria will take a valuation discount for lack of liquidity at
the end of her analysis.

RECONCILIATION OF VALUATION METHODS

The results of Victoria’s valuation analysis are:

Method Value

Income approach $31.7 million

Market approach 35.2 million

Average 33.5 million

Victoria chooses to weigh each method equally resulting in an average
value of $33.5 million. This value represents 100% of the common stock of
ACME at December 31, 2000, on an as-if-freely-traded and control basis.

DISCOUNT FOR LACK OF LIQUIDITY

Afreely tradedbasis means an investment can be sold and converted to cash
within several days. When shares of stock are sold on a public exchange, the
seller will usually receive cash within a few days making them freely traded in-
vestments. Under the income approach, Victoria used rates of returns from
publicly traded securities. Under the market approach, she used price multi-
ples of publicly traded shares. Thus, the values under both of Victoria’s ap-
proaches result in as-if-freely-traded values. Because it would likely take Bob
(or any other owner of the business) several months or longer to sell ACME and
receive cash, the liquidity of an investment in ACME’s shares is significantly
different than the liquidity of publicly traded shares of stock. Therefore, Vic-
toria takes a discount from the as-if-freely-traded value of $33.5 million for
ACME’s equity.
The preceding provides the rationale for applying a discount for lack of
liquidity. However, the amount of the discount must be quantified. The closest
empirical evidence to quantify the discount comes from studies of restricted
public stock prices and studies of share prices just prior to companies’ initial
public offerings. These studies indicate discounts for lack of marketability of
35% to 45% on average. Since these studies relate to minority equity positions
in the companies instead of control positions, Victoria uses a discount below
the averages of the studies. Based on her analysis and judgment, she applies a
10% lack of liquidity discount to the as-if-freely-traded $33.5 million equity