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Blockage Discounts in the Business Valuation World

Special thank you to guest blogger James Janos for sharing his insights with us!           

 

           A variety of discounts exist in the business valuation world. Discounts represent a deficiency in value that a buyer estimates for an asset compared to its peers. The most commonly observed discounts used by business valuation professionals are lack of control and marketability discounts. Other discounts frequently used are key-person and non-voting discounts. One of the less frequently discussed valuation discounts seen in the appraisal of publicly-held companies is the blockage discount.

             The best way to explain to the blockage discount to an individual unfamiliar with this concept or business valuation altogether is by explaining it through current events. President Trump’s nomination of ExxonMobil Corporation chief executive officer Rex Tillerson created a conflict of interest. ExxonMobil has global operations, and Tillerson could act on behalf of his former employer’s shareholders, and himself, as a government official. To avoid this conflict of interest Tillerson agreed to sell more than 600,000 Exxon shares worth more than $50 million at the beginning of 2017.

             Tillerson was not the first business executive leading a large company at the time of nomination to work for U.S. government. George P. Schultz was the Executive Vice President of the Bechtel Group before becoming Secretary of State under President Ronald Reagan, and Hank Paulson was the CEO of Goldman Sachs Group Inc. before his confirmation as Treasury Secretary. The difference between Schultz, and Tillerson and Paulson is that the later were executives of publicly-held companies, whereas the former was part of a private company.

             Unfortunately for Tillerson, by accepting the nomination and receiving confirmation by Congress, it is unlikely he will ever realize the $50 million in cash proceeds from his vested ExxonMobil shares because of the blockage discount. This discount represents a percentage deducted from the fair market value of a publicly traded stock to reflect the decrease in per share value. In large blocks of publicly-held stock that cannot be sold in a short time period given normal trading volume, the seller accepts per share value less than it otherwise would receive if it were not trying to liquidate its shares so quickly.

            Tillerson has some alternative options to trying to sell his large stake in ExxonMobil at once, though none are very good. For example he could sell the large block of shares slowly. This however increases exposure to the price fluctuations in ExxonMobil’s stock or a downturn in the market that could negatively impact the pool of potential buyers. Other alternatives like finding a broker, private investor, or privately placing the entire block are also options for the Secretary, but all lead to increased transaction costs and illiquidity issues. Increased costs and decreased liquidity all lead to a decreased price per share for Tillerson, in essence the same impact as the blockage discount.

             As of the date of this writing, the Secretary has yet to sell his interest in ExxonMobil. Nonetheless, Tillerson’s loss when he quickly liquidates the vested ExxonMobil shares represents a loss, but not a complete loss. As a result of a federal program known as certificate of divestiture offered since 1989 by the Office of Government Ethics, encoded in Section 2634 of federal ethics laws, was designed to ease the capital gains tax burden of quickly selling these shares for officials elected to or confirmed to the executive branch only. In 2006 Paulson was able to use this federal program when selling his nearly half billion dollars’ worth of Goldman stock to avoid an estimated $200 million in taxes.