At times, valuation analysts are called upon to value publicly traded stock. Common scenarios requiring independent valuation consulting are the presence of non-registered shares of stock in a company (that has other similar publicly registered and traded shares outstanding) that are restricted for certain time periods, or registered shares that might be subject to SEC restrictions on resale. Another common scenario involves blocks of publicly registered and publicly traded shares that might be so large that the sale of the block of shares in the public market within a short time period could materially influence the value.

A private company owner might sell his private company shares to a public company and receive as partial consideration shares in the public buyer that are not registered with the SEC and/or that are subject to certain transfer restrictions based upon the relationship between the private company seller and the public buyer. The private company seller might have to wait until the lapse of the transfer restrictions. Then he or she might also have to wait still further until the shares are publicly registered before he or she can sell them on the open market. Private company sellers attempt to negotiate provisions in the sale that require the public buyer to attempt to register their shares with the next public registration statement the buying public company makes (a piggyback registration right).

If the private company seller is unable to negotiate a registration right, he can attempt to sell the shares in a private placement under SEC Rule 144. Alternatively, if the private seller falls under the definition of an affiliate, the private seller’s eventual liquidation of their registered public shares must be done in accordance with SEC Rule 144, which can involve certain additional restrictions that could further slow the pace at which the private company seller can liquidate his or her position in the public company. Restricted stock studies provide background information on the basis and magnitude of the marketability discounts reflected in the various restricted stock studies.

Revenue Ruling 77-287 sets forth the guidelines for valuation of securities that cannot be immediately resold because they are restricted from resale pursuant to federal securities laws. The application of this ruling, and more particularly the SEC Institutional Investor Study, assists the valuation analyst in the determination of the appropriate level of marketability discount to apply in the valuation of restricted public shares or closely held securities.

Some valuation analysts also utilize option pricing methodology to determine the cost of acquiring the relevant options or collars to replicate the likely holding period of the restricted shares.

An owner of a large block of publicly traded stock, especially if that stock is in a thinly traded public company, could cause a supply or demand imbalance if he was to try to sell his large block of shares in a short period of time. The larger the block of shares in relation to the average daily trading volume of that same security, the larger the potential impact on the current market price. To induce buyers to acquire such a large block, a substantial “blockage discount” from the traded daily price might be required. The valuation analyst must consider factors including, but not limited to, the following:

• The period that might be required to liquidate the stock position, which takes into account the size of the block of shares and the average daily trading volume.
• The historical impact on the stock price of larger blocks of shares that were traded.
• The expected growth rate in the public company stock.
• The required rate of return of the public company stock.