The standard evidence-based construction has a ceiling, and the conventional figure sits above it.
Not at ordinary inputs. The protective-put method, the standard evidence-based construction, indicates 22.0 per cent at 45 per cent volatility, two and a half years to liquidity and a 4 per cent risk-free rate. Inverted, it never reaches 30 at that volatility: the put value peaks at 28.6 per cent, at 9.6 years, then declines as discounting the strike overtakes the growth in the option. Reaching 30 requires asserting volatility near 60 per cent in writing.
Worked in full in The Private Markets Valuation Specialist by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A discount for lack of marketability is legitimate in principle and abused in practice. The standard evidence-based way to size it values the cost of a protective put over the expected holding period — the price of the right to sell at today's value during a period in which the position cannot be sold at all. That construction turns an assertion about illiquidity into an arithmetic with named inputs: volatility, time to liquidity, and a risk-free rate. Each of them can be challenged by a reviewer. A convention cannot.
At 45 per cent volatility, two and a half years to liquidity and a 4 per cent risk-free rate, the construction indicates 22.0 per cent. That is the base case. Moving the inputs across a plausible range does not move the answer very far.
| Case | Volatility | Indicated discount |
|---|---|---|
| Eighteen months to liquidity | 30 per cent | 11.4 per cent |
| Base case, two and a half years | 45 per cent | 22.0 per cent |
| Four years to liquidity | 60 per cent | 34.7 per cent |
A real adjustment, and a modest one. Nothing in that range supports the figure most files reach for.
Convention says 30. The useful question is not whether 30 is defensible in the abstract, but which inputs would produce it. Hold the period fixed at two and a half years and volatility has to be 60 per cent. That is a specific assertion about the subject company, and it is the kind of assertion that has to be written down and defended rather than assumed.
Hold volatility at the base case instead, and solve for time, and the result is stranger. There is no holding period whatever that reaches 30 per cent. The put value rises with time, peaks at 28.6 per cent, and declines after that, because discounting the strike eventually overtakes the growth in the option.
| Quantity | Value |
|---|---|
| Indicated discount, base case | 22.0 per cent |
| Discount the convention asserts | 30 per cent |
| Volatility required to reach it over the base period | 60 per cent |
| Highest value reachable at base-case volatility, any period | 28.6 per cent |
| Holding period at which that peak occurs | 9.6 years |
A conventional 30 per cent marketability discount is not merely unevidenced at these inputs. It is unreachable by the method that is supposed to evidence it, at any holding period, unless volatility near 60 per cent is asserted in writing. Very few people applying the convention would assert that, which means the convention is doing something other than what its users believe it is doing.
One caution, because a finding of this shape invites over-claiming. The protective-put construction is one method among several, and on some readings it is a lower bound on illiquidity cost: it prices the loss of the ability to sell at today's price, not the loss of optionality over the whole period. The finding is not that 30 per cent is always wrong. It is that this method cannot produce 30 per cent at these inputs, so anyone using 30 per cent is relying on something else and owes the reader a sentence saying what.
The second way a marketability discount goes wrong is quieter. An asset bought below its listed peers already carries a discount, and adding a conventional one on top charges for the same illiquidity twice.
Take an entry multiple of 7.3 times against a listed peer median of 8.9 times on the same date. The entry price already embeds a discount of 18.0 per cent. Add a conventional 20 per cent and the two do not add to 38 — they compound to an effective 34.4 per cent. Supportable is 18.0. The double-count is 16.4 points, very nearly as much again as the discount that was justified.
On an enterprise value of 120 that is 19.7 of equity value removed twice. It is worth stating in money in the memorandum, because 16.4 points reads as a refinement and 19.7 of value does not.
The discipline here is not that marketability discounts are wrong. Sized with evidence they are real and modest, running from 11.4 to 34.7 per cent across the whole range above, and a specialist who sizes one properly will usually find it does less work than expected. It is the plug the discount becomes when it is not computed that does the damage — and the plug is the version that turns up in the files an auditor decides to test.
Sized with the protective-put method it is real and modest. At 30 per cent volatility over eighteen months it indicates 11.4 per cent; at 45 per cent volatility over two and a half years, 22.0 per cent; at 60 per cent volatility over four years, 34.7 per cent. The range is narrow enough that adopting a convention adds risk and nothing else.
Yes. An entry multiple of 7.3 times against a listed peer median of 8.9 times on the same date already embeds 18.0 per cent. Adding a conventional 20 per cent does not give 38; the two compound to 34.4 per cent. The double-count is 16.4 points, or 19.7 of equity value on an enterprise value of 120.
Less than most buyers assume. A fund interest reported at 50, with comparables down four per cent since the reporting date and a distribution of 3 received, rolls forward to 45. A bid of 34.41 is a headline discount of 31.2 points. Only 10 points are stale reporting; the other 21.2 points are the secondary market pricing the interest.
This article is one calculation from The Private Markets Valuation Specialist. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: private equity and private markets → · All 1706 articles →
If this book helped — or didn’t — a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.