The Pluris DLOM Database is one approach to calculating a Discount for Lack of Marketability for minority interests in private companies. Restricted stock private placement data is just one of many different forms of empirical evidence that might support and help determine the proper DLOM for any particular case.
However, whatever source of data you use for calculating a DLOM, it’s important that valuators understand the underlying theory of using a restricted stock study to compute a DLOM. The following questions and answers will provide you with a high-level overview of restricted stock based DLOM theory.
1. Why should I use the Pluris DLOM Database instead of standard restricted stock studies?
The Pluris DLOM Database is a restricted stock study, the difference being that the database is so vast (more than 4,400 transactions) that it allows you to do your own research and generate your own study instead of just relying on someone else’s research or an average discount.
2. How is the discount calculated?
For each of the transactions, the amount paid for the restricted stock is compared with the trading price for the same shares (same ticker) in the public markets at that point in time. The discount is calculated as one minus the price paid for the restricted stock divided by the price paid for the unrestricted stock. We believe this discount reflects the lower degree of liquidity or marketability enjoyed by the buyer of the private placement.
3. What kind of transactions are these?
Each transaction in the Pluris DLOM Database is a restricted stock private placement. The database has this in common with almost every other restricted stock study listed in the standard valuation textbooks (see, for example, Shannon Pratt’s Valuing a Business, 5th Ed., p. 431). Such private placement transactions are also commonly referred to as private investments in public equity (PIPEs).
4. Why do you include transactions in the database where warrants are attached to the shares?
It’s important to note, first, all the transactions in the Pluris DLOM Database are common stock private placements. In other words, an investor in a public company is buying restricted stock from the issuer. So, each transaction measures the discount applicable to restricted stock only. However, some issuers of restricted stock are unable to sell their shares without a “sweetener” – and those are typically in the form of warrants. The values of those warrants are, thus, part of the discount (the sweetener is really a form of a price concession) for the restricted shares bought.
Of the more than 4,400 transactions in the Pluris DLOM Database, some have no warrants attached, while some (less than half) do. However, we believe, based on published research, taking a sample of companies that can sell restricted stock without warrants attached would be a biased sample. The resulting discounts from such an analysis would be biased downward. We believe that this approach is inappropriate.
Nevertheless, since the Pluris DLOM Database includes data on transactions both with and without warrants, analysts who want to generate the discount without those transactions can easily do so.
5. I have heard that discounts for restricted stock are not reflective of the DLOM for private companies. Comment?
Yes and No. For the most typical, small, private placement of restricted stock, the discount would tend to be lower than what you would apply to a private company. However, these transactions are still useful to the business valuation expert. We call this discount the Restricted Stock Equivalent Discount (RSED). For the average private company, we think it’s appropriate to add an incremental discount on top of the RSED to get to the “full” DLOM. We use our database to generate this increment as well (see below).
6. Why would I calculate a warrant value then calculate a DLOM value off those calculations? The DLOM percentage doesn’t seem real to me. Isn’t it just a calculation of a calculation? Does the calculated RSED account for the inclusion of warrants?
It’s inaccurate to say that these are a calculation of a calculation. The discounts for all the transactions in the database are calculated as the difference between the price paid for the restricted stock purchased and the price the same (but unrestricted) stock was trading for in the public market at the same time. However, in some transactions, part of the total price was for warrants. (Typically, even in transactions with warrants attached, the part of the deal value that represents compensation for the warrants is small.) For those transactions, to arrive at the correct restricted stock discount, the warrant part must be deducted first. Luckily, there is secondary market trading indications for what these warrants are worth. These adjustments were already made in the Database, so the resulting discounts you see as a user are “pure” restricted stock discounts.
7. What is the RSED?
Restricted Stock Equivalent Discount (RSED0 was introduced as the fourth level of value in the early the 2000’s, and featured in articles and major publications (i.e., Shannon Pratt’s Valuing a Business) as part of the new level of value of framework. The RSED represents an illiquid position that is not fully non-marketable (between marketable minority and non-marketable minority). At the RSED level, an analyst will compare the key risk characteristics of the subject company to the transactions contained in the Pluris DLOM Database. The comparative framework typically includes an analysis of key risk metrics (i.e., size, balance sheet risk, volatility, etc.), and primary and secondary Standard Industrial Code data sets. To arrive at a non-marketable minority interest of privately held shares, an appraiser must make an additional illiquidity adjustment referred to as PEDI.
8. What is the PEDI?
PEDI is an acronym for Private Equity Discount Increment. Since private placement transactions primarily reflect positions that are more liquid than privately held stock, a PEDI is the second step in the analysis for determining the lack of marketability associated with non-marketable minority interests. PEDI is determined by comparing the discounts associated with the largest block (most illiquid) transactions to the average and median discount indications of all the transactions. Underlying this methodology is the notion that transactions in the largest blocks serve as the best proxy for the lack of marketability of any size positions in privately held companies. To see how the PEDI is calculated, download the PEDI Calculation Guide
9. What is the standard deviation, the median, and average discounts in the database?
Standard deviation = 0.303647
Average = 22.4%
Median = 20.8%
NOTE: These figures are from 2001 – 2013
10. To what extent has regression analysis been used on this data to determine if there truly are specific factors that influence the discount?
We have done significant regression analysis on the data to determine what factors influence the discount, some of which has been published. And we continue to explore indications from this research. As economic data, there is a significant natural variability in the discount. However, compared with other analyses, the Pluris DLOM Database stacks up very well in terms of statistical measures of “goodness of fit.” For practical valuation work, you may still choose to use other methods such as quartile analysis to estimate the DLOM. However, that analysis can be supplemented with regression testing to ensure that the factors you’re using are meaningful and statistically significant indicators of the discount.
11. What is a PIPE?
Private Investment in Public Equity (PIPE) refers to a form of growth capital investment made into a publicly traded company. PIPE investments are typically made in the form of equity or equity-linked security that is unregistered for a certain period.
12. In the Database, what volume stocks are low volume stocks?
When the common stock has a daily dollar trading volume of less than $5,000 a day. This is calculated as: transaction date closing price * last one-year average daily trading volume (or applicable average daily trading volume).
13. If the Pluris DLOM Database is better than Mandelbaum, where has it been used in court?
We don’t suggest that the Pluris DLOM Database is ‘better than Mandelbaum.’ We do, however, suggest that valuators who need to develop a DLOM should, as the court itself did in Mandelbaum, use a restricted stock study as part of the research and analysis in developing a DLOM, including the so-called ‘Mandelbaum’ factors.
The Pluris DLOM Database is the restricted stock study created by the individual valuator using the database that will be a part of the valuation and could be used as evidence in court. In defending a DLOM, the valuator can cite the criteria that were used to select the transactions that make up the restricted stock study and why those particular criteria were selected. When a source is cited in a court case, it is typically to justify some value derived from that source, such as a market multiple obtained from BIZCOMPS®, or a control premium from MergerStat. When a valuator uses the Pluris DLOM Database, they do not have to rely on an ‘average’ or ‘median’ DLOM derived from someone else’s study. Instead, they have all the comparative criteria that caused them to use the restricted stock transactions in developing their DLOM.
14. Has the Pluris DLOM Database met the Daubert test?
We recommend that the individual valuator using the Pluris DLOM Database draw data for the valuator’s own study of the DLOM as then use that data as evidence in court. In terms of Daubert tests, in the Gross case, the 6th Circuit Court of Appeals specifically addressed Daubert issues regarding Dr. Bajaj’s ‘novel’ method of using his own restricted stock study in developing a DLOM in and found it met the Daubert tests. (Gross v. CIR, 272 F. 3d, 333 (2001).
15. Can I search by SIC code?
Yes, the Database is searchable by 2-, 3-, and 4-digit SIC codes, as well as sixteen other search parameters, including volatility, market capitalization, revenue, assets, and block size.
16. Some authors say that SIC code doesn’t have much to do with the amount of discount. How do I find relevant transactions with the Pluris DLOM Database?
In the past, some authors have stressed that the financial risk of the issuing firm has more impact on the discount. This is probably true for most industry classifications. However, there may be industries where the DLOM is significantly different from the average for reasons having to do with the perceived attractiveness (or lack thereof) of an investment in that industry. Previous restricted stock studies simply never had enough data to evaluate this theory properly (not enough data points per SIC code). If you wish to pursue this approach as a supplement to other methods for developing your DLOM, the Pluris DLOM Database supports you with the ability to search on the SIC code in addition to such factors as block size, volatility, and market-to-book ratio to select the transactions for your restricted stock study.
17. How large is the database and what is the timeframe covered?
With over 4,400 transactions, Pluris DLOM has more than ten times as many transactions as other commercial databases. The data is updated quarterly to provide you with the most recent transactions for your valuations.
18. How are the PEDI numbers calculated, for example, 1.3x to 1.5x and 6% to 10%?
The numbers are calculated from the data. Records with the very largest blocks relative to average volume contained larger discounts. These large blocks were analyzed and compared to the entire database. Please see the explanation in Calculating the RSED and Calculating the PEDI, above.