Copyright Brian K. Pearson
All Rights Reserved

In 1999 we reviewed over 500 companies that had an Initial Public Offering (IPO). From those companies, we selected only those companies that had a transaction in their stock within 2 years from the IPO date. What follows is a condensed version of the results of our study, along with some discussion of the study.

Over the past several years, our firm, Valuation Advisors, LLC has studied marketability discounts in the shares of privately held companies as reflected from information disclosed in their Initial Public Offering (hereinafter IPO) prospectus. The prospectus is the document that the Company provides to potential investors to review before purchasing stock in the Company. The discounts used in our study are calculated from actual transactions in a Company's common stock or stock options as disclosed in the prospectus. The price paid for the stock or option in the months prior to the IPO is then compared to the IPO price to determine the implied marketability discount (or occasionally a premium).

The Valuation Advisors study reviewed over 500 Initial Public Offering prospectuses in 1999. Of those reviewed, only 336 fit the criteria for inclusion in our study. The general criterion was that the Company must have had a transaction in their stock (whether via sale, purchase or option) within two years of their IPO. The transaction must have been in the common stock of the Company. Many companies issued stock warrants, stock appreciation rights (SAR's), or had convertible preferred stock transactions. Although each of these transactions is eventually denominated in a common stock price, they don't represent a "pure" transaction in common stock. Typically as valuation experts we are asked to value common stock. Therefore, we excluded these non "pure" transactions from our study.

Many companies that had an IPO in 1999 did not have a transaction in their stock. Some of the more common reasons included mutual savings banks that converted to public stock ownership (thus no prior stock existed), companies that were spun-off from their parent company, and companies formed to do roll-up transactions. An IPO roll-up is where a new entity goes public by purchasing several similar companies simultaneous with the closing of the IPO. Some roll-up IPOs had good transactions in their stock or options, but they typically occurred at a larger than average marketability discount, presumably to reflect the fact that many of these roll-ups never make it to an IPO, and most have virtually no revenues or assets prior to the IPO. We also excluded foreign company IPOs, whose shares are sold as American Depository Receipts and any limited partnerships that went public.

In addition to the information that is provided to potential investors via a prospectus, companies must file a similar document with the Securities and Exchange Commission (SEC) called a Registration Statement (Form S-1). All the information used in our study was taken from the prospectuses provided to potential investors, not the Registration Statement filed with the SEC. Occasionally the disclosure in the Registration Statement filed with the SEC has even more information on such transactions than the investor prospectus. We point this out because the results of our study do not capture every available option or stock transaction. In fact, there are many transactions that go uncaptured. We can see some of these transactions (especially stock options) in the footnotes to the financial statements in the prospectus, where disclosure may be provided, but in a way that is insufficient to determine the price and/or time the transaction occurred.

Most of the transactions in our study were in the nature of stock options granted to owners, executives, or employees of the subject Company. Many transactions were also sales of stock and stock used as acquisition currency. In addition to actual transactions, we used stock values determined to be at Fair Market Value for existing options where the subject Company needed to calculate reportable compensation expense for outstanding options. Even then, we only used these transactions if it was clearly noted that such price was at Fair Market Value (FMV). In the majority of cases, this type of disclosure is provided by the Company.

Occasionally, the company was asked to make a compensation adjustment by the Securities and Exchange Commission (SEC), even though the option or stock sold/issued was noted at FMV. In these situations, we checked to see if the company had other transactions with third parties (typically convertible preferred stock with venture investors). If the company did have such transactions, we would compare the prices used by the company as FMV versus the transaction with third parties. If the company's FMV price was considerably different, we would exclude the transaction.

We took this approach after discussing how the SEC determines a compensation adjustment on so called "cheap" stock or options. They indicated that the prices paid with independent third parties such as venture capital investors are highly weighted in such determinations. Thus, although we haven't included convertible preferred stock transactions in our study, we have considered their impact where necessary.

Occasionally, where it could be easily calculated based on clear disclosure, we added the compensation adjustment to the stock or option price to determine FMV. In general, we strived to be as throrough as possible not to include any "cheap" stock or options in the study.

Where various transactions occurred in different time periods we used more than one transaction per subject Company. We did not however use more than one transaction per time period per Company. Where multiple transactions occurred within a time period, we used the transaction at the highest price. This was done to intentionally error on the low side of any valuation discounts determined. On several occasions, companies would disclose that the value of the stock or option was determined by an independent appraisal. In our discussions with the SEC, they indicated that a credible third party appraisal was seriously considered in determining FMV, much more so than a price determined by the company's board of directors. Clearly, we need to promote this more as a profession.

How is our IPO study different from earlier studies? First, to assist the reader in addressing the impact of the marketability discount by time period, we felt it was necessary to separate the transactions in smaller increments than the increments that were reported in the previous studies. Further, we have provided the complete study results, and various subsets. For instance, we have provided the results eliminating discounts above 90%, and below 10%. In addition, we have calculated our results both with and without companies that were profitable. Finally, we have assigned the appropriate North American Industry Classification System (NAICS) code to each company, and have provided an example of how this subset can be used.

From the companies that had a valid transaction in their stock, we separated the transactions into 5 time periods. The time periods were all measured from the IPO date. The time periods are 1-90 days, 91-180 days, 181-270 days, 271-365 days, and over 1 year but less than 2 years.