The question how best to value privately-held equity for various purposes remains an open debate. In general, valuation models are asset-based, income-based or hybrid models, etc. In this study, we focus on Option Pricing Methodology (OPM), one of the widely used valuation models. We evaluate the relative performance of Black-Scholes Model vis-à-vis Finnerty Model. We consider the valuation accuracy of both the models under different liquidation periods. Among various option pricing methodologies used to calculate Discount for Lack of Marketability (DLOM), Chaffee European Put Option Model (based on the Black-Scholes option pricing model) was found to be a better technique.

Holdings in publicly-traded companies always have more worth than those of privately-held companies. One of the major factors behind this is the lack of liquidity and marketability in closely-held stocks (private equity). Private equity lacks the ability of quick conversion of holding into cash at minimal cost. Therefore, it calls for a discount on its value, named as Discount for Lack of Marketability (DLOM). In simpler terms, DLOM is a downward adjustment made to the value of an investment reflecting its lower level of marketability. DLOMs as high as 20% to 40% are commonly used in practice for valuing small private businesses.

Interest in the publicly-traded companies can be sold within a small fraction of time, even over the telephone in seconds at the available market price. These public market transactions occur at a very small commission cost. The investor typically receives the transaction proceeds following a federally mandated settlement period of three business days. The number of potential buyers for privately-held companies vis-à-vis publicly-traded investments are very small. Without registering the closely-held securities with the regulators, it is illegal to sell them in general public. Security registration is an expensive and time-consuming process. Furthermore, a controlling stockholder is the only one who can register these shares for public trading. Because of the above-said restrictions, empirical evidence suggests the applicability of DLOM on the closely-held companies.

Applied Finance Journal, Option Pricing Methodology (OPM), Discount for Lack of Marketability (DLOM), Option Model, Black-Scholes, Option Pricing Models, Private Equity, Valuation, A Comparative Analysis.