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prior qualitative professional research and prior academic research. Then
we will present some additional data and come to some conclusions
about the magnitude of control premiums and DLOC.
The top portion of Figure 7-1 shows the traditional level of values
chart.3 The conventional wisdom represented in the traditional levels of
value chart holds that it is appropriate to add a control premium to the


F I G U R E 7-1

Traditional Levels of Value Chart


Level of Value Adjustment up To Adjustment Down To

Control interest Control premium NA
Marketable minority interest Reverse out DLOM DLOC
Private Minority Interest NA DLOM
Mercer™s Mercer (1998) modi¬ed traditional levels of value chart
Strategic value Value of synergies NA
Control value Control premium Eliminate synergies
Marketable minority interesta Reverse out DLOM DLOC
Private minority interest NA DLOM

a
Often referred to in the literature as the ˜˜as-if-freely-traded-value™™ for private ¬rms.




3. The bottom portion shows Chris Mercer™s modi¬ed traditional levels of value chart, which is
identical to the one above, except with the addition of the strategic value. We will cover this
later in the chapter.




CHAPTER 7 Adjusting for Levels of Control and Marketability 197
marketable minority interest value. There are signi¬cant opinions to the
contrary, i.e., that one should not add any control premium whatsoever.
Additionally, there is controversy over the appropriate magnitude of the
control premium among those who do add them to the marketable mi-
nority interest value. We will cover that in greater depth later in the chap-
ter. Of course, if the valuation method is a guideline company approach
using a database of sales of privately held ¬rms, the starting value is a
private control interest, and a control premium is inappropriate.
It is extremely important to understand that the valuation adjust-
ments in Figure 7-1 be appropriate to the valuation method used. If we
are valuing a control interest and we used a discounted cash ¬‚ow analysis
with discount rates calculated using New York Stock Exchange data, the
resulting value is a marketable minority interest, and a control premium
must be considered.4
The alternative levels of value chart is two tiered, i.e., it is a 2 2
chart (2 rows and 2 columns, versus the traditional chart, which is 3
1). It represents the four basic types of ownership interests, which are
combinations of public versus private and control versus minority inter-
est. Obviously, there are shades of gray in between the extremes. Bolotsky
(1991) was the ¬rst to propound this chart, although he used it for slightly
different purposes, which we discuss below. Much later in the chapter,
we will discuss Figure 7-3, which is my own extension of Bolotsky™s levels
of value chart to a 3 2 chart.
The traditional sources of control premiums are the Mergerstat and
the Houlihan Lokey Howard & Zukin (HLHZ) studies.5 Table 7-1, col-
umns B and C show Mergerstat™s compilation of average (mean) and
median ¬ve-day acquisition premiums from 1985“1997. The premiums
were measured as (POffer/P5Day) 1, where the numerator is the offering
price and the denominator is the minority trading price ¬ve days before
the announcement of the offer. Mean acquisition premiums have ranged
from 35“45%, with the average being 39.5% (B21), while median premi-
ums have ranged from 27“35%, with an average of 30.5% (C21).



F I G U R E 7-2

Two-Tiered Levels of Value Charta


Public Private

Control x x
Minority x x

a
Note: these are also the four basic types of ownership interests.




4. It is also important to make sure the measure of income is consistent with the interest valued.
When valuing a control interest, it is appropriate to add back excess salaries of the owners.
When valuing a minority interest that cannot force salaries lower, the add-back is
inappropriate.
5. HLHZ now owns Mergerstat, although the latter was previously owned by Merrill Lynch and
the W. T. Grimm Co.




PART 3 Adjusting for Control and Marketability
198
T A B L E 7-1

Synergies as Measured by Acquisition Minus Going-Private Premiums


A B C D E F G

5 Acquisition Going Private Difference
Premiums [1] Prem [2] Synergy?

6 Mean Median Mean Median Mean Median
7 1985 37.1% 27.7% 30.9% 25.7% 6.2% 2.0%
8 1986 38.2% 29.9% 31.9% 26.1% 6.3% 3.8%
9 1987 38.3% 30.8% 34.8% 30.9% 3.5% 0.1%
10 1988 41.9% 30.9% 33.8% 26.3% 8.1% 4.6%
11 1989 41.0% 29.0% 35.0% 22.7% 6.0% 6.3%
12 1990 42.0% 32.0% 34.3% 31.6% 7.7% 0.4%
13 1991 35.1% 29.4% 23.8% 20.0% 11.3% 9.4%
14 1992 41.0% 34.7% 24.8% 8.1% 16.2% 26.6%
15 1993 38.7% 33.0% 34.7% 20.0% 4.0% 13.0%
16 1994 41.9% 35.0% 41.9% 35.0% 0.0% 0.0%
17 1995 44.7% 29.2% 29.8% 19.2% 14.9% 10.0%
18 1996 36.6% 27.3% 34.8% 26.2% 1.8% 1.1%
19 1997 35.7% 27.5% 30.4% 24.5% 5.3% 3.0%
20 1998 40.7% 30.1% 29.1% 20.4% 11.6% 9.7%
21 Mean 39.5% 30.5% 32.1% 24.1% 7.4% 6.4%

[1] Mergerstat-1999, Chart 1-8, Page 23 (Mergerstat-1994, Figure 41, Page 98 for 1985-1988). Mergerstat is a division of Houlihan
Lokey Howard & Zukin.
[2] Mergerstat-1999, Table 1-39, Page 42. For 1985-1988, Mergerstat-1994, Figure 39, Page 96.




Note that we deliberately use the term acquisition premium instead of
the more common term control premium. Eventually we will distinguish
between the amounts that are paid for control versus the amounts that
are paid for synergies, as the latter are generally part of investment value
and not fair market value.
The mean and median going-private premiums are 32.1% and 24.1%
(D21 and E21), and the difference of means and medians of acquisition
versus going private premiums are 7.4% and 6.4%, respectively. At a ¬rst
glance, it would seem that the 7.4% mean or 6.4% median difference is a
potential measure of synergies, as going private transactions do not have
synergies. Also, the 32.1% mean or 24.1% median going private premium
would be good candidates as a benchmark for measuring control pre-
miums.
Table 7-1A shows additional detail of the premiums as measured by
different points in time. An n-day acquisition premium is equal to
PAnnouncement
1, where the denominator is the stock price n days before
Pn
the announcement date. It is clear that acquisition premiums increase
with an increase in n, as can be seen by moving to the right across any
row. Rows 6 and 7 show median and mean acquisition premiums for
ordinary acquisitions, while columns B through D in rows 10 and 11 show
the same premiums with the potential 7.4% synergies from Table 7-1, F21
subtracted. These are a net acquisition premium for ordinary acquisitions



CHAPTER 7 Adjusting for Levels of Control and Marketability 199
T A B L E 7-1A

Acquisition and Going-Private Transactions Premiums


A B C D F G H J K L

Going Private
4 Ordinary Acquisitions Transactions Difference

5 Gross Acquisition Premiums 1 Day 5 Days 30 Days 1 Day 5 Days 30 Days 1 Day 5 Days 30 Days
6 Median 22.8% 28.4% 36.7%
7 Mean (with max. of 100%) [1] 27.2% 32.9% 42.7%
9 Premiums net of 7.4% synergies
10 Median 15.4% 21.0% 29.3% 20.0% 23.0% 26.9% 4.6% 2.0% 2.4%
11 Mean (with max. of 100%) [1] 19.8% 25.5% 35.3% 25.7% 27.2% 31.7% 5.9% 1.7% 3.6%

[1] All premiums 100% treated as 100%
Data Source: Mergerstat database. This contains going private premiums from 3/89 to 5/98 and ordinary acquisition premiums from 12/83 to 1/99. There are 46 to 69 going private
premiums and 1,175 to 1,430 ordinary premiums.




that is a candidate for the control premium. Columns F through H in
rows 10 and 11 are the going private transactions, and columns J through
L are the difference of the net acquisition premiums for ordinary acqui-
sitions and the going private premiums. Notice that only the one-day
differences at 4.6% and 5.9% (J10 and J11) are signi¬cant in size, while
the ¬ve-day and thirty-day differences are quite small. Again it seems
that going private premiums are a strong contender for the measure of
the value of control.
The traditional calculation of discount for lack of control (DLOC) is
based on the control premium. If the marketable minority FMV is $100
per share and one buys control for $140 per share, the control premium
(CP) is $40 per share. In percentages, the premium is $40 per share di-
vided by the marketable minority price of $100 per share, or $40/$100
40%. Going in the other direction, DLOC is the $40 premium divided by
the control price of $140, or 28.6%. Symbolically, DLOC CP/(1 CP).
The vast majority of valuation assignments for valuation profession-
als call for a fair market value standard of value. Unless a market is
dominated by strategic buyers and the subject company is a reasonable
candidate to be bought by a strategic buyer in the mergers & acquisitions
(M&A) market, it is necessary to remove any synergistic element in ac-
quisition premiums before applying a control premium. The data are con-
fusing, and there are different ideological camps in the valuation profes-
sion. The goal of the control section of this chapter is to present a large
body of professional and academic research, arrive at a coherent expla-
nation of the diverse data, and provide guidance and quantitative bench-
marks for use in the profession.


Prior Research”Qualitative Professional
As mentioned earlier, we examine two types of prior research: profes-
sional and academic. In this section we examine prior professional re-
search on control premiums. The professional research itself is composed
of a long series of articles that develop important valuation theory that

PART 3 Adjusting for Control and Marketability
200
is primarily qualitative. We will now review the main articles, which are
written by Eric Nath, Chris Mercer, Michael Bolotsky, and Wayne Jan-
kowske. Again, because control and marketability are so intertwined,
these articles also contain material relevant to adjusting for marketability.

Nath
The original attack on the traditional position came from Eric Nath (1990).
Nath later clari¬ed and slightly modi¬ed his initial position (Nath 1994
and 1997). Nath argued:
— Fewer than 4% of all public ¬rms are taken over each year.
Using an ef¬cient markets hypothesis argument, Nath said that
the LBO funds, strategic buyers, and their bankers, who
collectively represent hundreds of billions of dollars scouring the
market for deals, keep the market clean. Any good takeover
opportunity will not last long. If there were hidden premiums in
the ¬rms, their stock prices would rapidly be bid up to that
level.
— Minority shares in publicly held ¬rms are liquid. The existence of
liquidity tends to eliminate nonstrategic acquisition premiums if
the companies are well managed and management
communicates effectively with investors (I would add that they
must be benevolent to minority interests, which is the usual case
in publicly held ¬rms and is not usual in privately held ¬rms).
— The previous points lead to the conclusion that the publicly
traded prices are control values and not just minority values. His
major conclusion, which contradicts conventional wisdom of the
three-tiered levels of value chart, is that starting from a public
market derived value, one must take both DLOM and DLOC to
value a privately held minority interest. Apparently in¬‚uenced
by articles from Bolotsky and Jankowske, both discussed below,
Nath later (1997) switched to the two-tiered levels of value
structure. Doing so had no material effect on his conclusions,
merely the presentation.
— Buyers are often strategically motivated, and therefore what they
pay is not equivalent to FMV. Nath™s evidence is that similar
premiums are paid for minority interest acquisitions. More
recently, his position has modi¬ed. Nath is concerned whether
the market of relevant buyers for a subject company is likely to
consist of many strategic buyers who would participate in an
auction for the company. If so, then he contends that strategic
value essentially becomes fair market value. If there are not
many strategic buyers, then he is still concerned that the M&A
multiples may contain a strategic element in the acquisition
premium, leading to overvaluation of the company unless that
element is removed. He determines this by an analysis of three
entities: the company itself, the market for ¬rms in that industry,
and the M&A databases.
— Several problems with the computations of control premiums
cause them to be misleading. Mergerstat™s control premium
statistics exclude acquisition discounts, i.e., some acquisitions

CHAPTER 7 Adjusting for Levels of Control and Marketability 201
occur at lower prices than the minority trading price. Other
problems are that the range of premiums is enormous and
Mergerstat uses simple averages instead of market weighted
averages.
— There are at least two additional problems in using takeover
prices as an indicator of value. The ¬rst is that transactions are
unique and time-speci¬c. Just because a speci¬c buyer pays a
speci¬c premium for a particular ¬rm, that does not mean that
another buyer would pay a similar premium for a comparable
¬rm, let alone for a much smaller and less exciting company. The
second problem, Nath contends, is that some people overpay.
These points are related to the comments above on the strategic
element of acquisition premiums in the M&A market.

Mercer (1990)
In his initial article on the topic, Mercer (1990) disagreed with Nath.6
Mercer was the most notable proponent of the traditional viewpoint and
levels of value chart. He disagreed with Nath™s belief that ¬rms that are
taken over are different than those that are not, which led him to disagree
with Nath™s conclusion that the public minority price is a control value.
Bolotsky (1991) said that that is a matter of opinion and cannot be tested.
Mercer also contested Nath™s statement that most takeovers are fully
or partially motivated by strategic reasons and that this makes the trans-
action prices unsuitable measures of FMV. Essentially, Mercer said that
buyer motivations are irrelevant and that it is not up to us to question
their motivations”just to use the data generated by their actions.
He also wrote that premiums paid for minority interests are premi-
ums paid for creeping control, not for synergies. Bolotsky agreed with
Mercer on this point.
Mercer has since changed his views considerably, and we will cover
his 1998 article separately in this professional review.

Bolotsky7
Michael Bolotsky (1991) and (1995) agrees with many of Nath™s criticisms
of conventional wisdom but disagrees with his conclusions. With regard
to the results of his analysis, he represents a middle position between
Mercer and Nath. With regard to the theoretical underpinnings, his work
is unique in that it is the ¬rst article that abandons the linear levels of
value concept entirely and replaces it with a multifactor, multidimension
matrix of fundamental attributes. For example, he gets rid of the concept
that 100% ownership value must always be somehow higher than or
equal to minority ownership value. He contends that both Mercer and
Nath are still arguing around a linear concept of going from ˜˜up here™™
to ˜˜down there.™™
Bolotsky has a comprehensive, logical framework of analysis that
includes differences in ownership rights, liquidity, information access,


6. He has since changed his views considerably, and we will cover his 1998 article later.
7. I thank Michael Bolotsky for editing this section and helping me to interpret his work correctly.




PART 3 Adjusting for Control and Marketability
202
and information reliability between the four types of ownership interests
listed in Figure 7-2. Bolotsky™s article is important theoretical work and
obviously in¬‚uenced subsequent articles by both Nath and Mercer. Bol-
otsky™s article contains no empirical evidence nor any attempt to quantify
the implications of his framework into an economic model. The practical
signi¬cance of the article is that he disagrees with Nath™s conclusion that
valuing a private minority interest with reference to public minority in-
terests as a starting point requires applying both a DLOM and a DLOC.
It is signi¬cant that Bolotsky did not attempt to squash four levels
of value (public-control, public-minority, private-control, and private-
minority) into three, as both Nath and Mercer did.8 Bolotsky™s assertion
that the more the buy side knows about the seller and the more he or
she can rely on it, the higher the price, is also signi¬cant and logical.
Bolotsky characterized the public markets as a consensus opinion of
value that may occasionally experience an anomalous trade, but that trade
will be quickly bid back to a rational, equilibrium consensus value. He
says:
[T]he purchase of an entire company is typically a one-time purchase of a
unique item; the price that ultimately gets recorded is not the consensus
opinion of the limited group of buyers and sellers for a particular entire
company but is rather the winning bid, which is normally the highest bid.
There is no ˜˜market™™ process going on here in the sense described above
for public minority blocks. It is analogous to a situation where the single
anomalous trade described earlier does not get rapidly bid down to a con-
sensus price; instead, it gets memorialized in Mergerstat Review, to be re-
lied upon by valuation consultants. Clearly, relative to fair market value,
there is an upwards bias in prices that represent either the highest bid, the
only bid, or the bid of a buyer bringing special attributes to the table.
Bolotsky takes a middle position on whether the takeovers are for
typical or atypical public companies, the former position being taken by
Mercer and the latter by Nath. Bolotsky says that it is inappropriate to
insist that unless a subject company is in play, one must assume there is
no control premium. He thus disagrees with Nath on that point.
Bolotsky™s theoretical framework has no concept of sequential levels
of value, with control value at the top, followed by minority marketable
value, and nonmarketable minority value at the bottom. Rather, Bolotsky
advances the concept that the value of various types of ownership inter-
ests is the result of building up the contribution to value of fundamental
ownership attributes, to the degree that each attribute applies to the in-
terest in question. In addition, Bolotsky™s framework implies that rather
than discounts and premiums, there are adjustments for differences in own-
ership attributes and that the adjustment can be positive, negative, or
zero. In this framework there is nothing that mandates that a 100% own-


8. Nath stopped doing that in his December 1997 article. Until fairly recently, Mercer believed that
there are only three levels of value, as he contends that there is no discount for lack of
marketability (DLOM) for private control interests, as the private control interest has control
over cash ¬‚ows (I disagree that control over cash ¬‚ows eliminates DLOM and will cover
that later in the chapter). He has more recently added a strategic level of value, as shown in
the lower section of Figure 7-1, but it is still linear, i.e., a single column of values.




CHAPTER 7 Adjusting for Levels of Control and Marketability 203
ership position will be equal to or greater in value than a public minority
price; indeed, Bolotsky™s framework implies that if investors in a security
value liquidity and the options that liquidity provides to a greater degree
than they value power, then public minority pricing for that security will
exceed 100% ownership pricing.
Thus, Bolotsky says that for those public companies where we would
conclude that the per share 100% ownership value is the same amount
as the public minority value, the two prices might be the same but for
very different reasons. In effect, the same price for different ownership
interests is resulting from the net of the differences in the impact of var-
ious ownership attributes on each interest. Since the concept is of the net
of differences, there is no reason why the net difference in price between
a 100% ownership position and a public minority position cannot be zero
or even negative. Accordingly, when we state that the public minority
value and the 100% ownership value are the same, we are really saying
that we should apply a net value adjustment of zero. I agree with his
position that there is a very important distinction in saying we are ap-
plying a net zero premium versus saying that by de¬nition there is no
premium.
Bolotsky also states that Nath™s conclusion is internally ¬‚awed in that
in valuing private minority interests with reference to public minority
prices as a starting point we need to take both a DLOM and a DLOC. He
argues that if a public minority block of shares happens to have the same

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