oftenneedthehelpofexpertstojudgevalue.This
adds to the cost in the process.- Thetradingcostsassociatedwithbuyingandsellinga
private business can range from substantial to
prohibitive,dependingonthesizeofthebusiness,the
compositionofitsassets,anditsprofitability.There
are relatively few potential buyers, and the search
costs(associatedwith findingthesebuyers)willbe
high.Laterin thischapter,weputtheconventional
practice of applying 20 to 30 percent illiquidity
discounts to thevaluesofprivate businessesunder
the microscope. - The difficulties associated with selling private
businessescanspilloverintosmallerequitystakesin
thesebusinesses.Thus,private equityinvestorsand
venture capitalists have to consider the potential
illiquidityoftheirprivatecompanyinvestmentswhen
consideringhowmuchtheyshouldpayforthem(and
whatstaketheyshoulddemandinprivatebusinesses
in return).
Insummary,thecostsoftradingassetsthatareusuallynot
traded are likely to be substantial.
COST OF ILLIQUIDITY: THEORY
Thenotionthatinvestorswillpaylessforilliquidassetsthan
for otherwise similar liquid assets is neither new nor
revolutionary. Overthe past two decades researchers have
examined the effect of illiquidity on value using three
different approaches. In thefirst, the value of an asset is
reducedbythepresentvalueofexpectedfuturetransactions