Page 46 - Business Valuation for Estates & Gift Taxes

excess of 100 percent. However, while such indications occur using Longstaff with relatively short hold-
ing periods and lower volatilities, a protracted holding period and high volatility are requisite inputs
when using the Finnerty model.

Finally, Ronald Seaman has published numerous articles on the use of long-term equity anticipation se-
curities (LEAPS) as an option-based technique for estimating liquidity discounts. LEAPS are publicly
listed and traded options, usually on stocks with larger capitalizations. LEAPS, when issued, can have
terms of as long as three years. The quoted price of the LEAPS in relationship to price of the underlying
security produces an indicated discount. Furthermore, using the price of the LEAPS and other data relat-
ing to the underlying security and the option term, an analyst can use a Black-Scholes variant to deter-
mine the implied (forward) volatility for the stock over the life of the LEAPS and use that volatility in
conjunction with other elements of the overall analysis. To the extent that the holding period for the pri-
vately traded security is expected to materially exceed the remaining life of the LEAPS, the LEAPS in-
dications would typically provide a lower bound to the discount unless it can be demonstrated that the
public companies would be likely to be far more volatile that the expected volatility of the privately held
security. fn 10

Conclusion

Notwithstanding the variety of approaches available for estimating a discount for lack of marketability,
there is a remarkable and logical consistency throughout all of the analytical elements:

 The longer the period of restriction, the greater the discount.

 The greater the risk (whether measured by profitability, volatility, market capitalization, or any
other measure), the greater the discount.

The valuation analyst will need to decide based on the facts and circumstances of his or her engagement
which approach is most suitable and which will produce the strongest case for the reported conclusion of
value.

fn 10
In 2009, the IRS issued "Discount for Lack of Marketability—Job Aid for IRS Valuation Professionals" to provide non-
authoritative guidance on methodologies and considerations when applying discounts for lack of marketability to assets. See
www.irs.gov/Businesses/Valuation-of-Assets.

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