Pre-IPO studies should be at the center of the DLOM debate


BVR's programming on DLOM issues continues to spur debate about how to support marketability discount conclusions, but with a new restricted stock study on the market (Pluris), and more focus on probability-based models like OPM, poor old pre-IPO studies seems to be getting less attention.  They shouldn't be.   For one thing, the IRS itself uses the Valuation Advisors Pre-IPO study.

Few other choices besides Valuation Advisors. The VA study has more transactions than any other DLOM database of any kind, and will soon also include 1000 international transactions as well.  In addition, the two other major pre-IPO studies are either out of date (Emery) or not available to the public (WMA).  Meanwhile, Brian Pearson at VA has been adding and updating transactions weekly throughout the summer (including 350 last week).

Irony, thy name is pre-IPO. Pearson hears many myths about pre-IPO studies, but that in fact all these misperceptions make DLOM's derived from VA more conservative than they might be otherwise.   Point out the fact that your DLOM is understated the next time some one challenges your conclusion.  For example:

Myth 1:  Underwriters intentionally underprice IPOs. "Would an ownership team leave perhaps millions on the table to avoid the embarrassment of a first day drop in stock price?  Hardly," Pearson says.  So, it's unlikely that pre-IPO discounts would be exaggerated by fear of a bad first day on the market.

Myth 2:  Insider deals are underpriced. The SEC audits every IPO, and as every one knows, the reporting standards are now so severe that fewer and fewer companies are choosing this exit strategy.  Plus, Pearson says "we already adjust option pricing based on SEC adjustments in compensation to provide 'fair value' numbers."  So, unfair "cheap stock" pricing factors are eliminated.

Myth 3:  The market affects post-IPO pricing. Obviously, but that's not a factor in DLOM considerations, since it's "after the fact."

Myth 4:  Unsuccessful deals are excluded creating a bias. Pearson is particularly perplexed by this concern.  He cites the fact that 8 companies cancelled IPOs in the first week that the market went down dramatically--even though they'd invested all the filing costs and had done the road shows and everything.   For these 8 companies, the result was severely curtailed liquidity opportunities, and a complete reconfiguring of exit timetables--failing to go public does not increase value somehow.   So, the fact that unsuccessful deals are omitted means that the VA database "understates DLOM," Pearson points out.   Including them would only increase discounts.

Will international deals change DLOM calculations, particularly for foreign companies doing US business?   Pearson says no--initially based on studies he's done of IPOs on the Toronto Stock Exchange (TSE) vs the US Exchanges.   But there's also a logical reason that the discounts don't vary much internationally.  "If there was a difference, the big ibanks would immediately start buying on the discounted exchange, and selling on the less discounted exchange.   If this were to happen, pricing equilibrium would be achieved very quickly," he says.

"The difference in DLOM for international companies doing IPOs is very small, if it exists at all," Pearson concludes.


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