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compiled by Partnership Pro¬les, Ltd.
2. My regression analysis of private fractional interest data.
Thus, in Chapter 10 we use three models for calculating the fractional
interest discount: the economic components model, the partnership pro-
¬les database regression, and the private data regression.
If any chapter may have rough edges to it, Chapter 7 is it. I hope to
be able to smooth those edges in future editions of this book. For now,
however, this chapter will have to remain as it is.
The calculation of the discount for lack of control in Chapter 9 is also
subject to further research and revision. Nevertheless, this is valuable and
novel material well worth the struggle through the quantitative parts.
I caution the reader not to get bogged down in the quantitative parts
of Chapter 7. Read it through lightly ¬rst for understanding the gist, and
do not worry about understanding every statistic in the academic articles.
The most important thing to get out of Chapter 7 in a ¬rst reading is an
understanding of why the acquisition premium data that we have been
using for the past 30 years tell us almost nothing useful about the value
of control of a private ¬rm and why we have to look elsewhere. It is then
worth a second reading to master the technical details.




PART 3 Adjusting for Control and Marketability 193
CHAPTER 7


Adjusting for Levels of Control
and Marketability




INTRODUCTION
THE VALUE OF CONTROL AND ADJUSTING FOR LEVEL OF
CONTROL
Prior Research”Qualitative Professional
Nath
Mercer (1990)
Bolotsky
Jankowske
Roach
Mercer (1998) and (1999)
Summary of Professional Research on Control Premiums
Prior Research”Academic
Schwert (1996)
Lease, McConnell, and Mikkelson (1983)
Megginson (1990)
My Conclusions from the Megginson Results
My Analysis of the Megginson Results
The Houlihan Lokey Howard & Zukin (HLHZ) Study
International Voting Rights Premia
Bradley, Desai, and Kim (1988)
Maquieira, Megginson, and Nail (1998)
Other Corporate Control Research
Menyah and Paudyal
My Synthesis and Analysis
Decomposing the Acquisition Premium
Inferences from the Academic Articles
The Disappearing Control Premium
The Control Premium Reappears
Estimating the Control Premium
DLOC



195




Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use.
DISCOUNT FOR LACK OF MARKETABILITY (DLOM)
Mercer™s Quantitative Marketability Discount Model
Kasper™s BAS Model
Restricted Stock Discounts
Regression of MPI Data
Using the Put Option Model to Calculate DLOM of Restricted
Stock
Annualized Standard Deviation of Continuously Compounded
Returns
Calculation of the Discount
Table 7-8: Black“Scholes Put Model Results
Comparison of the Put Model and the Regression Model
Empirical versus Theoretical Black“Scholes
Comparison to the Quantitative Marketability Discount Model
(QMDM)
Abrams™ Economic Components Model
Component #1: The Delay to Sale
Psychology
Black“Scholes Options Pricing Model
Other Models of Component #1
Abrams Regression of the Management Planning, Inc. Data
Limitations of the Regression
Component #2: Buyer Monopsony Power
Component #3: Transactions Costs
Table 7-11: Quantifying Transactions Costs for Buyer and Seller
Component #3 Is Different than #1 and #2
Developing Formulas to Calculate DLOM Component #3
A Simpli¬ed Example of Sellers™ Transactions Costs
Tables 7-12 and 7-13: Proving Formulas (7-9) and (7-9a)
Value Remaining Formula and the Total Discount
Table 7-14: Sample Calculation of DLOM
Evidence from the Institute of Business Appraisers
Mercer™s Rebuttal
Expected Growth and Expected Returns
Conclusion
My Counterpoints
Mercer™s Response
Conclusion
MATHEMATICAL APPENDIX




PART 3 Adjusting for Control and Marketability
196
INTRODUCTION
Adjusting for levels of control and marketability is a complicated and
very important topic. We will be discussing control premiums (CP), their
opposite, discount for lack of control (DLOC), and discount for lack of
marketability (DLOM).
Historically, these valuation adjustments have accounted for substan-
tial adjustments in appraisal reports”often 20“40% of the net present
value of the cash ¬‚ows”and yet valuation analysts may spend little to
no time calculating and explaining these adjustments.
This is a long chapter, with much data and analysis. It will be helpful
to break the discussion into two parts. The ¬rst part will deal with pri-
marily with control and the second part primarily with marketability. I
say primarily, because the two concepts are interrelated. The level of con-
trol of a business interest impacts its level of marketability. Therefore, it
is logical to begin with a discussion of control. Because of the interrela-
tionship, two academic articles that we will discuss in the section on
control relate more to marketability, yet they ¬t in better in the control
discussion.


THE VALUE OF CONTROL AND ADJUSTING FOR LEVEL
OF CONTROL
We will begin our analysis of the effects of control on value by reviewing
prior qualitative professional research and prior academic research. Then
we will present some additional data and come to some conclusions
about the magnitude of control premiums and DLOC.
The top portion of Figure 7-1 shows the traditional level of values
chart.3 The conventional wisdom represented in the traditional levels of
value chart holds that it is appropriate to add a control premium to the


F I G U R E 7-1

Traditional Levels of Value Chart


Level of Value Adjustment up To Adjustment Down To

Control interest Control premium NA
Marketable minority interest Reverse out DLOM DLOC
Private Minority Interest NA DLOM
Mercer™s Mercer (1998) modi¬ed traditional levels of value chart
Strategic value Value of synergies NA
Control value Control premium Eliminate synergies
Marketable minority interesta Reverse out DLOM DLOC
Private minority interest NA DLOM

a
Often referred to in the literature as the ˜˜as-if-freely-traded-value™™ for private ¬rms.




3. The bottom portion shows Chris Mercer™s modi¬ed traditional levels of value chart, which is
identical to the one above, except with the addition of the strategic value. We will cover this
later in the chapter.




CHAPTER 7 Adjusting for Levels of Control and Marketability 197
marketable minority interest value. There are signi¬cant opinions to the
contrary, i.e., that one should not add any control premium whatsoever.
Additionally, there is controversy over the appropriate magnitude of the
control premium among those who do add them to the marketable mi-
nority interest value. We will cover that in greater depth later in the chap-
ter. Of course, if the valuation method is a guideline company approach
using a database of sales of privately held ¬rms, the starting value is a
private control interest, and a control premium is inappropriate.
It is extremely important to understand that the valuation adjust-
ments in Figure 7-1 be appropriate to the valuation method used. If we
are valuing a control interest and we used a discounted cash ¬‚ow analysis
with discount rates calculated using New York Stock Exchange data, the
resulting value is a marketable minority interest, and a control premium
must be considered.4
The alternative levels of value chart is two tiered, i.e., it is a 2 2
chart (2 rows and 2 columns, versus the traditional chart, which is 3
1). It represents the four basic types of ownership interests, which are
combinations of public versus private and control versus minority inter-
est. Obviously, there are shades of gray in between the extremes. Bolotsky
(1991) was the ¬rst to propound this chart, although he used it for slightly
different purposes, which we discuss below. Much later in the chapter,
we will discuss Figure 7-3, which is my own extension of Bolotsky™s levels
of value chart to a 3 2 chart.
The traditional sources of control premiums are the Mergerstat and
the Houlihan Lokey Howard & Zukin (HLHZ) studies.5 Table 7-1, col-
umns B and C show Mergerstat™s compilation of average (mean) and
median ¬ve-day acquisition premiums from 1985“1997. The premiums
were measured as (POffer/P5Day) 1, where the numerator is the offering
price and the denominator is the minority trading price ¬ve days before
the announcement of the offer. Mean acquisition premiums have ranged
from 35“45%, with the average being 39.5% (B21), while median premi-
ums have ranged from 27“35%, with an average of 30.5% (C21).



F I G U R E 7-2

Two-Tiered Levels of Value Charta


Public Private

Control x x
Minority x x

a
Note: these are also the four basic types of ownership interests.




4. It is also important to make sure the measure of income is consistent with the interest valued.
When valuing a control interest, it is appropriate to add back excess salaries of the owners.
When valuing a minority interest that cannot force salaries lower, the add-back is
inappropriate.
5. HLHZ now owns Mergerstat, although the latter was previously owned by Merrill Lynch and
the W. T. Grimm Co.




PART 3 Adjusting for Control and Marketability
198
T A B L E 7-1

Synergies as Measured by Acquisition Minus Going-Private Premiums


A B C D E F G

5 Acquisition Going Private Difference
Premiums [1] Prem [2] Synergy?

6 Mean Median Mean Median Mean Median
7 1985 37.1% 27.7% 30.9% 25.7% 6.2% 2.0%
8 1986 38.2% 29.9% 31.9% 26.1% 6.3% 3.8%
9 1987 38.3% 30.8% 34.8% 30.9% 3.5% 0.1%
10 1988 41.9% 30.9% 33.8% 26.3% 8.1% 4.6%
11 1989 41.0% 29.0% 35.0% 22.7% 6.0% 6.3%
12 1990 42.0% 32.0% 34.3% 31.6% 7.7% 0.4%
13 1991 35.1% 29.4% 23.8% 20.0% 11.3% 9.4%
14 1992 41.0% 34.7% 24.8% 8.1% 16.2% 26.6%
15 1993 38.7% 33.0% 34.7% 20.0% 4.0% 13.0%
16 1994 41.9% 35.0% 41.9% 35.0% 0.0% 0.0%
17 1995 44.7% 29.2% 29.8% 19.2% 14.9% 10.0%
18 1996 36.6% 27.3% 34.8% 26.2% 1.8% 1.1%
19 1997 35.7% 27.5% 30.4% 24.5% 5.3% 3.0%
20 1998 40.7% 30.1% 29.1% 20.4% 11.6% 9.7%
21 Mean 39.5% 30.5% 32.1% 24.1% 7.4% 6.4%

[1] Mergerstat-1999, Chart 1-8, Page 23 (Mergerstat-1994, Figure 41, Page 98 for 1985-1988). Mergerstat is a division of Houlihan
Lokey Howard & Zukin.

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