I was particularly pleased to read his June 28th post entitled “The Quantitative Marketability Discount Model and the [Expected] Holding Period.” I love the way the post begins:
Chris Mercer’s Quantitative Marketability Discount Model (QMDM) is a present value-based model of the lack of marketability discount (LOMD). It incorporates expected cash flows, rates of return, and holding periods. To the best of my knowledge, nobody has refuted its logic. (emphasis added)
Rand is, of course, correct. No one has yet refuted the logic of the QMDM, which is a shareholder-level discounted cash flow model. The QMDM is precisely analogous to the DCF Method for valuing business enterprises. It just focuses on shareholder-level expected cash flows, expected investment holding periods, and risks at the shareholder level – all in relationship to the underlying enterprise cash flows and value.
For those who may have been reluctant to use the QMDM for whatever reason, listen to Rand:
I have used the QMDM in every LOMD analysis I have completed since the late 1990’s – well over 1,000 of them – when the QMDM was published [Quantifying Marketability Discounts was published in 1997]. I also use benchmarking and option-based models to give me three LOMD indications. Each uses different data and methodologies. I synthesize them to arrive at my LOMD. Modesty aside, nobody has ever refuted my LOMD conclusions. (emphasis added)
Rand uses the term Lack of Marketability Discount (LOMD) for what I call the marketability discount, and others call the Discount for Lack of Marketability (DLOM). I and others at Mercer Capital have used the QMDM in virtually every minority interest appraisal where a marketability discount was applied since about 1994 – several thousand of them. With success, as well.
I hope that you will take time right now to read Rand’s QMDM blog post. If you currently use the QMDM, you will appreciate his insights into the expected holding period. He also suggests alternative ways to use the model to help support or give confidence in marketability discount indications from other methods.
Like this blog, the IBA blog accepts reader comments. I posted the following comment there.
____________________Start of Comment on IBA Blog by Chris Mercer___________________________
After reading this post about the QMDM, I think I’m ready to start using the model!
Thanks so much for an eloquent and reasoned overview of the QMDM. I plan to give your post as wide a distribution as possible. Your post leads me to this comment, which flows from your observations:
If an appraiser is not “comfortable” using the QMDM to value illiquid minority interests because of the sensitivity of the model’s output to changes in conclusions, or that over a range of assumptions, the model develops a range of indications for marketability discounts, then he or she should NEVER use the discounted cash flow model to value a business. Why? Because they both apply the discounted cash flow method to value things. And they are both subject to the same criticisms.
And speaking of never, there is a small typo in the quote from p. 244 of Quantifying Marketability Discounts Revised Reprint. [Out of print. For current thinking on the QMDM, see Business Valuation: An Integrated Theory, 2nd Edition.] It now reads:
“In the final analysis, the hypothetical willing investor, or the business valuation analyst as her proxy, must make a realistic range estimate of the probable holding period…It is almost never possible to make an informed judgment about a relatively short holding period (say five years or less) or a relatively long holding period (say more than ten years) or something in between.”
Where it reads “It is almost never possible…” is should state “…it is normally possible…” Your post clearly understands the correct quotation.
It is normally possible to make an informed judgment as to whether, given the facts and circumstances in a particular valuation, the expected holding period might be relatively short, relatively long, or something in between. The QMDM enables the analyst to articulate these facts in quantitative form, and then to make an informed judgment regarding their impact on the resulting marketability discount (or DLOM or LOMD).
One thing I have said many times — if a reasonable range of assumptions for the QMDM yields a range of implied marketability discounts, even a relatively wide range, the appraiser should be comforted that he or she is make an informed decision within the right range.
_______________________End of Comment on IBA Blog by Chris Mercer___________________________
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