How Much Can Lack of Marketability Affect Private Equity Fund Values?
44 Pages Posted: 16 Jan 2015
Date Written: September 25, 2014
This paper derives a simple upper bound on the discounts for lack of marketability of private equity funds using option-pricing theory. The derived upper bound is a function of the return volatility of a private equity fund, of the (remaining) lifetime of the fund, and of two other parameters governing the speed of capital drawdowns and distributions. The model calibration and analysis delivers several novel insights about how non-marketability affects the value of private equity funds: (i) upper boundary discounts are an increasing function of the return volatility and of the average time over which a dollar committed to a fund is actually invested in the fund; (ii) upper boundary discounts decrease non-linearly over the finite lifetime of a fund; (iii) discounts for lack of marketability can potentially be large given that funds have a typical lifetime of 10 to 15 years. Estimated upper boundary discounts at the start of an average private equity fund equal $21.5 relative to $100 committed, i.e., an investor that has committed $100 to a private equity fund would be willing to pay up to $21.5 additionally in order to obtain immediacy in liquidating his position. By interpreting this figure as a compensation required by investors for non-marketability, the upper boundary return premium demanded for lack of marketability equals around 4 percent p.a.; and (iv) estimated upper boundary discounts of venture capital and buyout funds are around the same magnitude, though, discounts of the venture capital funds are slightly higher.
Keywords: Private equity funds, marketability, option-pricing
JEL Classification: G13, G23, G24
Suggested Citation: Suggested Citation