101 Concepts for the Level I Exam

Essential Concept 61: Valuation Discounts and Premiums for Private Companies

Two factors that affect the valuation of private companies are issues related to control and marketability.

When valuing the total equity of a private company, a control premium is added if publicly traded companies are used as the basis for pricing multiple.

Discounts for lack of control are used to convert a controlling interest value into a non-controlling equity interest value. The formula for a discount for lack of control is given by:

$\mathrm{DLOC=1-}\left[\frac{\mathrm{1}}{\mathrm{1+Control\ premium}}\right]$

A discount for lack of marketability (DLOM) is an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.

DLOM can be estimated based on data from private sales of restricted stock in public companies relative to their freely traded share price, stock sales prior to an IPO, and the pricing of put options.

A DLOM may not be appropriate if there is a high likelihood of a liquidity event in the immediate future.

DLOC and DLOM are multiplicative and not additive.

$\mathrm{Total\ discount\ =\ 1\ }-\mathrm{\ [(1-D}\mathrm{LOC)(1-DLOM)]}$