Venture-Backed Company on the Verge of Going Public via IPO.listed on exchanges) are all liquid whereas privately-held companies are all illiquid is a vast oversimplification.įor instance, let’s compare the liquidity of two different companies: The statement that publicly-trading stocks (i.e. Source: The Illiquidity Discount? Illiquidity of Public Stocks vs. “What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns? “Ignore” in this case equals “stick with through harrowing times when you might sell if you had to face up to the full losses.” Patience in terms of timing an exit can often benefit long-term return prospects. Why? An investor cannot “panic sell” and is basically forced to hold onto the investment regardless of the near-term volatility in price movements. The preference for liquid assets with frequent pricing appeals to short-term investors, such as traders, but one alternative perspective is that the forced long-term holding periods of illiquid assets could potentially result in better returns. Enroll Today Illiquidity and Long-Term Investing Enrollment is open for the May 1 - Jun 25 cohort. Level up your career with the world's most recognized private equity investing program. Thus, depending on the circumstances, the illiquidity discount can be as low as 2% to 5%, or as high as 50%.Īnd Wall Street Prep Private Equity Certificate Program However, the illiquidity discount is a subjective adjustment for the buyer and a function of the particular company’s financial profile and capitalization. The size of the illiquidity discount is largely up for debate, but for most private companies, the discount tends to range between 20-30% of the estimated value as a general rule of thumb. In practice, the value of the asset is first calculated ignoring the fact that it is illiquid, and then at the end of the valuation process, a downward adjustment is made (i.e. Learn More → The Cost of Illiquidity (Source: Damodaran) Discount For Lack of Marketability (DLOM)Īll else being equal, illiquidity results in a negative impact on the valuation of an asset, which is why investors expect more compensation for the added risk.Ĭonversely, a liquidity premium can be added to the valuation of an asset that can easily be sold/exited. assets that could be sold even if the valuation were to decline). The size of the illiquidity discount is contingent on the opportunity cost of tying up the capital to the investment as compared to investing in assets with lower risk (i.e. venture capital) require illiquidity discounts because of the long-term holding period for when their capital contribution is locked up. The more illiquid an asset is, the greater the discount expected by investors for the incremental risk of purchasing an investment with limited flexibility of selling in the future.įor example, early-stage investors (e.g.
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