Buy-Sell Agreements Process-Busting Valuation Issues (Part 3 of 4)

(Excerpted from Chapter 20 of the book Buy-Sell Agreements for Closely Held and Family Business Owners)

Marketability (or Illiquidity) Discounts Applied to Controlling Interests

Many buy-sell agreements with valuation processes provide guidance suggesting that appraisers should apply no discounts because of the minority nature of any holding and that there should be no discount for the lack of marketability of shares. The purpose of this guidance is to attempt to lead to a financial control level of value (see Chapter 14 of Buy-Sell Agreements for Closely Held and Family Business Owners), and to ensure that minority interests are not discounted for their lack of marketability.

There are appraisers who still apply a so-called “marketability discount” to controlling interests of businesses. They sometimes use a different label, like illiquidity, but the effect is the same.

There is no theoretical basis for a marketability or illiquidity discount applicable to controlling interests in businesses. I wrote an article on this topic because of confusion in the appraisal profession.(*)  You may want to suggest that your advisors read it before you sign your buy-sell agreement or while you are in the process of updating it.

Suffice it to say that if two appraisers value a business at $1,000 each and one takes a 25% illiquidity discount (or a discount by some other name that accomplishes the same thing), you will have a valuation dispute.

For more information or to purchase your copy of the book, Buy-Sell Agreements for Closely Held and Family Business Owners, click here.

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* See my article “Are Marketability Discounts Applicable to Controlling Interests in Private Companies?” Valuation Strategies, November/December 1997.