Marketability discounts in healthcare equity valuation

Marketability discounts are a topic of great debate in the valuation community.  In a recent article Shannon Pratt, the following points are raised in regard to the DLOM:

  • Per Pratt, the FMV Restricted Stock Database and the Valuation Advisor Lack of Marketability (Pre-IPO) Database are the most commonly used data sources.
  • Comparables should be selected based on rigorous screening by sales or assets to narrow-in on size.
  • A larger company tends to have a larger DLOM.
  • The more profitable a company is, the lower the DLOM.
  • Besides obvious outliers, one should take efforts to eliminate insider transactions which skew the marketability effect (non-arms length)
  • To adjust for the effect of insider transactions, one needs to adjust separately for changes in earnings related to “insider transactions” and the “IPO event”.

On another note, within the Healthcare industry subsector of valuation I have noticed that many do not use discounts for marketability at all.  I don’t agree with this stance.  The valuation literature tells us that we need to adjust the results of the Income Approach for DLOM if we have used a cost of capital derived from public market data.  I used a modified form of a Mandelbaum analysis to hone in on a more narrow adjustment, but I don’t feel the DLOM should be summarily avoided in healthcare business valuation.

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