David Fein, CEO of ValuSource sat down with Espen Robak and Eric Liu of Pluris DLOM to get a bebehind-the-scenesook at The Pluris DLOM Database.
The Pluris DLOM Database is one of the largest restricted stocks DLOM databases available, giving you the widest possible range of industries and company sizes. The data is updated quarterly to ensure it is in line with the three key characteristics the courts like to see in the calculation of discount rates:
- Data drawn from restricted stock studies
- Data drawn from similar companies
- Data drawn from recent transactions
History
After completing his MBA in 1994, Espen Robak began his career in the valuation industry valuing private entities and determining marketability discounts. “My work focused on calculating marketability discounts and how to find the right data and evidence to support my calculations,” says Espen. “Specifically calculating things like private interests in non-publicly traded companies. In other words, privately owned companies.”
Prior to forming Pluris, Espen was Senior Vice President of FMV Opinions, where he directed the firm’s restricted stock and blockage discount practices, including heading up the FMV Restricted Stock Study (now called the Stout Study), a published database of private placement transactions, as well as authoring several publications on private placements, restricted stock, and marketability discounts.
With time Espen knew he wanted to focus on valuing illiquid securities and illiquid company interests in private companies. With this type of valuation, accurately calculating the discount for lack of marketability (DLOM) is crucial and the type of data needed simply wasn’t available.
“Since I had experience compiling databases in my previous roles and there clearly was a gap in the market, I decided to create one that would offer consistently high quality, dependable data which the industry needed to establish a standard for calculating the DLOM,” says Espen.
In 2006 Espen founded Pluris Valuation Advisors LLC and began developing the data that would become the Pluris DLOM database. At around the same time, Eric Liu joined Pluris as an analyst. Eric had previously worked in China during the early days of the internet where he also graduated with a bachelor’s degree in communication engineering.
“After coming to the USA, I completed my MBA majoring in financial management. The combination of my expertise and my interest in finance and PIPE transactions made Pluris the perfect fit for me. Then in 2015, I earned my CFA certification,” says Eric.
The Evolution of Pluris DLOM
In 2006, the U.S. Financial Accounting Standards Board (FASB) introduced the accounting standard known as FAS 157 (No. 157, Fair Value Measurements) which was a classification system designed to bring clarity to the balance sheet assets of corporations. Later it would become the Accounting Standards Code Topic 820.
FAS 157 was based on the idea of an “exit price” and a 3-level hierarchy to reflect the level of judgment involved in estimating fair values, ranging from market-based prices to illiquid Level 3 assets where no observable market exists and valuations must be based on proprietary internal information, like the most recent round of funding.
“It was this shift that caused asset managers to start focusing on illiquid assets and how to value them,” says Espen. “This was a windfall for Pluris because it made the Pluris data even more relevant. Suddenly, anyone reporting or with audited financial statements needed to get a true idea of the value of their illiquid assets.”
Where does Pluris DLOM data come from?
Pluris data is drawn from the SEC’s EDGAR database as well as a private database called Private Raise. “We trawl through the data using a set of rules to specifically find PIPE (Private Investment in Public Equity) transactions which is a way for companies to raise capital quickly,” says Eric. “This would be any transaction where a publicly traded company sells a large amount of stock to private investors at a negotiated price.”
Taking an Automated Approach to Accuracy and Consistency
The accuracy and consistency of Pluris DLOM data is maintained through a systematic approach to gathering the data. “We have very formal rules in place for what gets included and what is not,” says Eric. “This automated approach eliminates any bias that could skew the data. The more time you spend manually sifting through data, subjectively deciding which transactions to use and not to use, the more inconsistencies you may introduce to the data collection process.”
The data included in Pluris DLOM goes back 10-years. Without an automated approach, the data could be skewed over time simply because the methods used would vary by analyst and manager. The decisions made would directly impact the quality and consistency of data.
Restricted stock in the context of valuation – Public Companies
“To understand how the data is applied, say you have a company trading at $10 a share and they need outside investment, so they look for private investors, maybe they find a hedge fund and get a $10 million investment, selling the shares at $7 a share,” says Espen. “Part of the terms of the deal are that they must keep the stock for a period of time, so it’s sold for less because it’s restricted. In this example, the illiquid non-marketable shares are sold for $7 a share, that’s a 30% discount for lack or marketability.”
DLOM in Private Company Transactions
The data is also applied to private companies when calculating illiquid restricted stocks and marketability discounts. “When we value a privately owned company, let’s just say you value a simple family-owned business, we value them based on market multiples from liquid securities, so you put that PE or market multiple of five and multiply by earnings of $1 million dollars, you get a value of $5 million,” says Espen. “Since this is the ‘liquid’ value, there must be a discount for lack of marketability on a non-controlling liquid level or non-controlling non-marketable level. And then from there, we may take an additional discount for lack of control. This is standard across the entire appraisal profession.”
We then take this one step further by adding a Private Equity Discount Increment (PEDI) to the Restricted Stock Equivalent Discount (RSED). Since the stocks are only restricted temporarily, we look at substantial percentage interests in public companies as the basis for that Private Equity Discount Increment. The PEDI also represents the additional amount required because these PIPE transactions do have a marketplace whereas a private interest usually does not.
“The reason is that a very large percentage interest in a public company is essentially the same as owning shares in a private company because it’s so big. You couldn’t get rid of it other than in a private transaction,” says Espen.
DLOM in Business Valuation
In the business valuation space, DLOM is a contentious and complex subject. There are many factors which impact a DLOM calculation and business valuators often ask what the discount range should be.
“We tell our users that there is an incredibly wide range of discounts, but typical discounts at the restricted stock equivalent level is probably anywhere between 15% and 25%,” says Espen. “For the smallest most illiquid, riskiest type of investments, it could be well into the 30s and 40s. And then on top of that, if you add a private equity discount increment of 5%, 10% or 15% the discount gets even bigger.”
“We see this in everything we do here. When valuing private companies, warrants, restricted stock, converts, desirable securities, wherever there is greater risk, the DLOM is larger,” says Eric. “If you’re stuck with a risky investment there is a much greater level of concern.”
DLOM and the IRS
In an audit situation, whether you are working on the side of the IRS or the taxpayer, the DLOM is a contentious issue since it is often a big adjustment to the value of an interest in a private company. It is often heavily negotiated and argued over.
“In this type of scenario, we also have other types of approaches to marketability discounts to further support the calculation,” says Eric. “We often see auditors using approaches like Discounted Cash Flow, or pre-IPO data, but we always gravitate towards restricted stock data because it represents an actual transaction. It’s hard evidence and it’s I think better than a spreadsheet with a bunch of hypothetical factors.”
This evidence-based approach is best practice across the industry. “Restricted stock transactions represent a view of the value of the exact same shares and the exact same company on the same day,” says Eric. “Since these are public companies the transactions represent, on a specific day, both the stock price in the market and the price for the illiquid shares.”
Pluris DLOM Court Tested
Pluris DLOM data is widely used by business valuation professionals, the IRS and is very often used in litigation. The data’s pedigree makes it well respected because it is very persuasive in a court setting and for audits situations. The data is also used by many other firms for reporting purposes.
What advice would you give to valuators in approaching this complicated topic?
“Look at it from as many different perspectives as possible, right, and always update yourselves. Always look for the best data,” says Espen. “If you have a huge database you’ve gathered from various sources or you’re using Pluris data or some other data source, try and reanalyze it occasionally. Ask yourself if you should develop different metrics or should look at it from a different perspective or relook at your models.”
“It’s very important to look at the most recent data because the economy is always in flux,” adds Eric. “And look at the data for at least the last 12 to 24 months. This will help you make a better assessment of the liquidity of the asset and can update your analysis accordingly.”
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About Espen Robak and Pluris
Espen Robak is President and founder of Pluris Valuation Advisors LLC and a nationally recognized expert on intellectual property and business valuation, restricted and illiquid securities, securities design, levels of value, and discounts for lack of liquidity. Pluris’ practice includes portfolio valuations for investment funds and financial institutions, as well as a broad range of financial reporting and tax opinions for public and private companies. He is a frequent contributor to books and professional journals on valuation, accounting, and taxation topics and his commentary has been quoted in the Wall Street Journal, Financial Times, The New York Times, American Banker, Bloomberg, Absolute Return, and Accredited Investor, among others. He is an editorial advisory board member for Trusts & Estates.
About Eric Liu
Eric Liu, Vice President, heads up Pluris’ portfolio valuation group. Mr. Liu’s career has been focused on the valuation of restricted stock, warrants, convertibles, debentures, auction rate securities, municipal bonds, and other hard-to-value, illiquid securities for financial reporting, litigation support, and other purposes. He is primarily in charge of research on illiquid securities, including the construction and maintenance of the LiquiStat™ database as well as the Pluris DLOM Database™. Mr. Liu also has overall responsibility for developing valuation models for PIPE securities, auction rate securities, limited partnership interests, bankruptcy claims, and other illiquid assets.