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Strategic Risk Taking: A Framework for Risk Management by Aswath Damodaran

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Appendix 5.2: Estimating the Illiquidity Discount

In conventional valuation, there is little scope for showing the effect of illiquidity. The cash flows are expected, the discount rate is usually reflective of the risk in the cash flows, and the present value we obtain is the value for a liquid business. With publicly traded firms, we then use this value, making the implicit assumption that illiquidity is not a large enough problem to factor into valuation. In private company valuations, analysts have been less willing (with good reason) to make this assumption. The standard practice in many private company valuations is to apply an illiquidity discount to this value. But how large should this discount be, and how can we best estimate it? This ...

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