How much can lack of marketability affect private equity fund values?

Abstract

This paper derives an upper bound on the discounts for lack of marketability of private equity funds using option‐pricing theory. The upper bound is a function of the volatility of the fund returns, of the (remaining) lifetime of the fund, of two parameters governing the speed of capital drawdowns and distributions, of the volatility of the stock market returns, and of the return correlation between the fund and the stock market. The model calibration and numerical analysis deliver several novel insights about how non‐marketability affects the value: (i) upper boundary discounts are increasing functions of the return volatility of the fund, of the return volatility of the stock market, and of the average time over which a dollar committed remains invested in the fund; (ii) upper boundary discounts decrease non‐linearly over the finite lifetime of a fund; (iii) estimated upper boundary discounts at the start of an average private equity fund equal $35.3 relative to $100 committed, which corresponds to an annual upper boundary return premium demanded for lack of marketability of around 7%; and (iv) estimated upper boundary discounts of venture and buyout funds are around the same magnitude, though, discounts of venture capital funds are slightly higher.

Marketability Discount in Various Economic Environments. Comparison of Developed and Emerging Markets on the Example of the USA and Poland

“…Borrowing future profits has its limitations, and reporting higher profits before IPOs causes their excessive decline in the next period. Buchner (2016), in his work, examined the size of the discount for the lack of liquidity of private equity funds. His research showed that the upper limit of the discount for lack of liquidity is 7%.…”

Minority Discount for Reduced Powers in Negotiations of Non-Listed Minority Holdings: Evidence from European Countries

“…Some researchers and practitioners have also focused on the valuation of minority discount for lack of marketability in the sale/purchase transactions of minority interests which cannot be easily sold to third parties within a reasonable period of time and for a fair value due to their absolute irrelevance from qualitative and quantity stand-point (Buchner, 2016;Chipalkatti & Luft, 2013;Finnerty, 2013;Lazar & Prisman, 2012). Notwithstanding such issue falls outside the scope of this article and it is a discount applied to minority interests in companies listed on official markets, similarly to the previous circumstance, also this one has some common points therefore it may be taken partially as reference in this analysis.…”