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BVR What It’s Worth Free Download Is the Lingering Criticism of Using Pre-IPO Studies for DLOM Justified? Originally published in the February 2014 issue of the Business Valuation Update. Thank you for visiting Business Valuation Resources, the leading provider of quality acquisition data and analysis. For more information about any of our premier valuation products or services, please call (503) 291-7963 ext. 2 or email [email protected]. You may also download our complete product brochure at: www.bvresources.com/allproductbrochure For permission requests, please email [email protected]. Business Valuation Resources, LLC 1000 SW Broadway, Suite 1200 | Portland, OR 97205 (503) 291-7963 | [email protected] www.BVResources.com BUSINESS VALUATION UPDATE TIMELY NEWS, ANALYSIS, AND RESOURCES Vol. 20, No. 2, February 2014 FOR DEFENSIBLE VALUATIONS Is the Lingering Criticism of Using Pre-IPO Studies for DLOM Justified? The use of pre-IPO studies to measure a discount that] is not freely tradable.” In 2003, the Tax for lack of marketability has gained acceptance Court rejected the use of pre-IPO studies in among valuation analysts and the Tax Court even McCord v. Commissioner. Dr. Mukesh Bajaj though the method continues to be a target of was the expert witness for the IRS, and the some criticism. Of course, criticism can be made court opinion states: “[I]n his rebuttal testi- of all data that BV practitioners use. The trouble mony, Dr. Bajaj offers a compelling criticism is, this criticism can sometimes be based on “old” of both the Willamette studies and [the Emory facts, which can lead to misinformation. studies].” There was no such criticism directed at the Valuation Advisors Pre-IPO database. Pre-IPO studies and restricted stock studies are Bajaj proposed an alternative method that was the two general types of empirical evidence of the a variation of restricted stock analysis. existence and magnitude of the DLOM. Restricted stock studies compare the trading prices of a com- Valuation analysts have been extremely critical pany’s publicly held stock sold on the open market of the McCord decision. Restricted stocks are, with those of unregistered or restricted shares of by definition, stocks of publicly traded compa- the same company sold in private transactions. nies that are prohibited from public trading for The pre-IPO studies move a step closer to mea- some limited time. When the restrictions expire, suring DLOM for closely held business interests they can be freely sold into an established public than the restricted stock studies. They consist of market. But an interest in a private company that transactions in privately held stocks prior to an has no established market (and is not likely to initial public offering compared with the subse- ever have an established market) is less mar- quent public offering price in the same stock. ketable than the restricted stock of a public company. Therefore, DLOM calculations based Over the years, three main sources of pre-IPO on a group of restricted stocks need to have an data have emerged. The Willamette Management upward adjustment to reflect the lesser market- Associates studies cover the period from 1975 to ability of the closely held interest. 2002. The John Emory studies cover the period from 1980 to 2000. The Valuation Advisors Lack The alternative to using restricted stock studies is of Marketability Discount Study is an ongoing to use pre-IPO studies. Many valuation analysts study and commercial database that has current use both methods, plus information from other information and is updated regularly. sources. Regardless, there is some ongoing criti- cism over the use of pre-IPO studies to measure Key court cases. In 1998, the Tax Court recog- DLOM. nized the relevance of pre-IPO studies in Davis v. Commissioner, finding that “the prevaluation BVU recently sat down with Brian Pearson date data in the IPO studies are relevant and of Valuation Advisors LLC, who developed the provide some insight into the price differences Valuation Advisors Lack of Marketability Pre-IPO between stock that is freely tradable and [stock Discount Study. This is the only online database Reprinted with permission from Business Valuation Resources, LLC bvresources.com Is The Lingering Criticism Of Using Pre-ipo Studies For Dlom Justified? of pre-IPO privately owned stock, convertible BUSINESS VALUATION UPDATE preferred stock, and option transaction data from Executive Editor: Andrew Dzamba 1985 to the present, and it recently surpassed Publisher: Sarah Andersen the 10,000 mark in terms of the number of trans- Legal Editor: Sylvia Golden, Esq. actions in the database. This makes it the largest Managing Editor: Janice Prescott source of DLOM data for BV professionals. Desktop Editor: Monique Nijhout Customer Service: Retta Dodge BVU: What is the source of the information VP of Sales: Lexie Gross President: Lucretia Lyons contained in the study and database? CEO: David Foster Brian Pearson: Before a company has an IPO, it EDITORIAL ADVISORY BOARD files a prospectus with the SEC. These prospec- CHRISTINE BAKER THEODORE D. ISRAEL tuses are available through the SEC’s EDGAR CPA/ABV/CFF CPA/ABV/CFF, CVA MEYERS, HARRISON & PIA ECKHOFF ACCOUNTANCY CORP. database and also from the investment bankers NEW YORK, NY SAN RAFAEL, CA who underwrite the offering. We receive a copy NEIL J. BEATON JARED KAPLAN, ESQ. CPA/ABV, CFA, ASA MCDERMOTT, WILL & EMERY of each prospectus and review it. We then record ALVAREZ & MARSAL VALUATION CHICAGO, IL SERVICES GILBERT E. MATTHEWS CFA any transactions involving the company’s stock, SEATTLE, WA SUTTER SECURITIES INCORPORATED stock options, or convertible preferred stock SAN FRANCISCO, CA JOHN A. BOGDANSKI, ESQ. prior to going public (i.e., when it was still a LEWIS & CLARK Z. CHRISTOPHER MERCER LAW SCHOOL ASA, CFA MERCER CAPITAL private company). PORTLAND, OR MEMPHIS, TN ROD BURKERT JOHN W. PORTER, ESQ. BVU: Do you update the data base as new CPA/ABV, CVA BAKER & BOTTS BURKERT VALUATION ADVISORS, LLC HOUSTON, TX companies go public? MADISON, SD RONALD L. SEIGNEUR MICHAEL A. CRAIN MBA, ASA, CPA/ABV, CVA, CFF CPA/ABV, ASA, CFA, CFE SEIGNEUR GUSTAFSON BP: Yes. We get prospectuses for new IPOs THE FINANCIAL VALUATION GROUP LAKEWOOD, CO usually the week after they go public. It takes FORT LAUDERDALE, FL BRUCE SILVERSTEIN, ESQ. YOUNG, CONAWAY, STARGATT & some time to review the information and compile NANCY J. FANNON TAYLOR ASA, CPA/ABV, MCBA WILMINGTON, DE it for the database, but the database is updated MEYERS, HARRISON & PIA PORTLAND, ME JEFFREY S. TARBELL for new IPOs at least once per month. ASA, CFA JAY E. FISHMAN HOULIHAN LOKEY FASA, CBA SAN FRANCISCO, CA BVU: Does your study include all IPOs? FINANCIAL RESEARCH ASSOCIATES GARY R. TRUGMAN BALA CYNWYD, PA ASA, CPA/ABV, MCBA, MVS LYNNE Z. GOLD-BIKIN, ESQ. TRUGMAN VALUATION ASSOCIATES BP: Our database is exhaustive. It includes all PLANTATION, FL WEBER GALLAGHER NORRISTOWN, PA KEVIN R. YEANOPLOS IPOs except REITs, LPs, and companies with no CPA/ABV/CFF, ASA LANCE S. HALL, ASA BRUEGGEMAN & JOHNSON transactions. REITs and LPs typically pay high FMV OPINIONS YEANOPLOS, P.C. dividends, which give them a yield, which is dif- IRVINE, CA TUCSON, AZ ferent than most privately owned common stock, Business Valuation Update™ (ISSN 1088-4882) is published monthly by Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, which typically doesn’t pay recurring dividends. Portland, OR, 97205-3035. Periodicals Postage Paid at Portland, OR, and at additional mailing offices. Postmaster: Send address changes to LPs are pass-through entities, which typically Business Valuation Update™, Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, Portland, OR, 97205-3035. share profits with partners, whereas REITs, by The annual subscription price for the Business Valuation Update™ is $419. law, must distribute 85% of their current-year Low-cost site licenses are available for those wishing to distribute the BVU to their colleagues at the same firm. Contact our sales department for details. ordinary income to owners. Since these dif- Please feel free to contact us via email at customerservice@BVResources. com, via phone at 503-291-7963, via fax at 503-291-7955 or visit our web site ferences are significant, we choose to exclude at BVResources.com. Editorial and subscription requests may be made via email, mail, fax or phone. these transactions from the database. Please note that by submitting material to BVU, you are granting permission for the newsletter to republish your material in electronic form. BVU: There’s been some criticism over the Although the information in this newsletter has been obtained from sources that BVR believes to be reliable, we do not guarantee its accuracy, and such years about the data in the pre-IPO studies. information may be condensed or incomplete. This newsletter is intended for information purposes only, and it is not intended as financial, investment, One that is coming up recently is the issue legal, or consulting advice. of “double counting” of the discount. That Copyright 2014, Business Valuation Resources, LLC (BVR). All rights reserved. No part of this newsletter may be reproduced without express written is, some of the transactions in the database consent from BVR. are calculated with a DLOM already in them. Reprinted with permission from Business Valuation Resources, LLC 2 Business Valuation Update February 2014 Is The Lingering Criticism Of Using Pre-ipo Studies For Dlom Justified? BP: Double counting of discounts is not occur- are worth much less. Then the real “discount” is ring when viewed in the larger context of the likely larger, since I have no immediate or likely transaction. While it is true that some of the avenue to gain liquidity. transactions include a prior discount, it helps to BVU: There’s also been the argument that understand the process by which this “discount” IPOs are overpriced due to hype.

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