One of the topics I have learned about as I intern with GYF’s Business Valuation Group is how discounts are applied to adjust the value of closely held businesses based on characteristics of the business interest being valued. Discounts for lack of marketability (DLOM), lack of liquidity (DLOL), and lack of control (DLOC) are commonly utilized in business valuation, but these terms generally aren’t discussed in college courses, so I wasn’t familiar with them prior to my internship at GYF.
For those unfamiliar with the concepts, here is a brief overview of why these discounts are important when determining the value of an entity. If applicable, valuation discounts are applied multiplicatively to the value of a business to account for the costs and time required to find a buyer without a centralized market (DLOM) given the characteristics of the specific asset, costs to sell the business quickly due to illiquidity (DLOL), and the lower price demanded for a noncontrolling interest (DLOC). It should be noted that valuators may apply any combination of the three discounts depending on the interest being valued.
I was fascinated by this topic because of the parallels between valuation discounts and the price of publicly traded stock, which I am familiar with through my experience with the Student Managed Investment Fund at WVU. For example, blue chip stocks are frequently traded in high volumes and can be immediately sold. For these reasons, there is essentially no discount for lack of marketability or liquidity applied to them. However, publicly traded stocks with lower trading volumes, while marketable, typically demand higher spreads from market makers to compensate for the risk and costs associated with lower liquidity.
In most instances, publicly traded stock carries an implicit discount for lack of control. While shares may have voting rights, single shares don’t have the voting power to influence key decisions such as selecting a management team or board of governors and approving shareholder distributions. This is (partially) why buyouts of public companies demand a premium to market price, with examples including Twitter in 2022, Dell in 2013, and Hilton Hotels in 2007. In each of these examples, the buyers were willing to pay more for the ability to make decisions for the company. The added value that some buyers place on this decision-making power is why the discount for lack of control is applied when valuing ownership interests in private enterprises of less than or equal to 50%. These discounts can be beneficial for gift and estate planning and provide a more realistic estimation of value for transactions.
I found it interesting to learn about these discounts and the reasons why they are utilized by valuators. As I continue to work with the GYF valuation team, I am also learning more about the quantitative methods used to determine how large these discounts should be as a percentage of value. These methods include restricted stock studies for estimating the DLOM, bid-ask spread analysis and option pricing models for estimating the DLOL, and control premium studies for estimating the DLOC. Because these methods can be highly granular, and valuators rely on assumptions and judgement, many valuators opt for rounded discount percentages to avoid implying excess precision. At GYF, we carefully consider the specific characteristics and circumstances of each valuation engagement to determine appropriate discount levels.
I learned a lot in my valuation class at WVU, taught by Ashok Abbott, who is a recognized expert in valuation. However, being able to learn through experience at GYF has helped me better understand practical application of valuation principles. I am thankful to have the opportunity to learn from the Business Valuation & Litigation Support Services team this summer. Melissa Bizyak, current partner leading the group, and Bob Grossman, one of the firm’s founding partners, have served for decades as thought leaders in the field and have built a respected valuation practice at GYF. I appreciate being able to learn from their work and expertise, and I will seek more opportunities to further develop my valuation knowledge as I continue my educational and professional development.
Although my internship will soon be coming to an end, this experience has piqued my interest in business valuation as a career path. I plan to pursue the Certified Valuation Analyst (CVA) credentials in addition to my Certified Public Accountant (CPA) license. My internship at GYF this summer has been very valuable, and has served as a bridge between academics and the professional world. I strongly encourage my peers to pursue internships so they can gain practical experience and learn what career paths are right for them.
