Absolute off market pricing

What Is Absolute Off-Market Pricing?

Absolute Off-Market Pricing refers to the specific, agreed-upon price for an asset that is transacted outside of traditional, public exchanges. It is a concept central to valuation in private markets, where assets are often illiquid assets and lack readily observable market prices. Unlike public securities that trade on organized exchanges with continuous price discovery, assets subject to absolute off-market pricing are typically bought and sold through direct negotiations between parties, often involving private equity firms, venture capital funds, or individual investors. This pricing mechanism is distinct because the price is determined through a bespoke agreement rather than through a competitive bidding process on an open market.

History and Origin

The concept of valuing assets and transacting them outside of public forums has roots stretching back to ancient civilizations, where land and goods were often exchanged through direct negotiation or barter long before formalized markets existed. Early forms of real estate transactions, for example, involved direct agreements for land transfers in Mesopotamia around 3,000 B.C., with details recorded on clay tablets⁸. As societies evolved, private property rights became more defined, laying the groundwork for complex private sales.

In the modern financial era, absolute off-market pricing gained prominence with the rise of private capital markets. The mid-20th century saw the formalization of private investment vehicles, such as venture capital funds and private equity firms, which primarily deal in assets not listed on public exchanges. Regulatory frameworks, such as the U.S. Securities and Exchange Commission's (SEC) Regulation D, introduced rules for private placements, allowing companies to raise capital without the extensive registration requirements of a public offering, provided they adhere to specific conditions regarding investor types and solicitation⁶, ⁷. This regulatory environment facilitated the growth of direct, negotiated transactions, making absolute off-market pricing a standard practice for a vast array of private assets.

Key Takeaways

• Absolute off-market pricing is the final, agreed-upon price for an asset traded outside public exchanges.
• It is prevalent in private markets, where assets are typically illiquid and lack transparent pricing.
• The price is determined primarily through direct negotiation and various valuation models.
• Unlike market-driven prices, absolute off-market pricing does not reflect continuous supply and demand from a broad base of participants.
• Due diligence and expert appraisal play a critical role in establishing such prices.

Formula and Calculation

Absolute off-market pricing itself does not have a single, universal formula because it is the outcome of a negotiated agreement rather than a calculation. However, the determination of this price is heavily influenced by various financial analysis and valuation methodologies. These methods provide a basis for the parties involved to negotiate and arrive at the absolute off-market price. Common methodologies include:

1. Discounted Cash Flow (DCF) Analysis: This method projects the future cash flows of an asset and discounts them back to their present value using an appropriate discount rate.

   $$PV = \sum_{t=1}^{n} \frac{CF_t}{(1+r)^t} + \frac{TV}{(1+r)^n}$$

   Where:

   • (PV) = Present Value
   • (CF_t) = Cash Flow at time (t)
   • (r) = Discount Rate (reflecting risk and time value of money)
   • (n) = Number of periods
   • (TV) = Terminal Value (value of cash flows beyond the projection period)

2. Comparable Sales Analysis: This approach involves examining the prices of similar assets that have recently been sold in private transactions or, if available, in thinly traded public markets. While direct comparables can be scarce for truly unique off-market assets, this method provides a market-based benchmark.

3. Asset-Based Valuation: For assets with tangible underlying components, this method sums the fair value of an asset's individual components (e.g., equipment, property, inventory) to arrive at a total value.

The final absolute off-market price is often a blend of insights from these methods, adjusted for specific factors, and ultimately agreed upon through negotiation.

Interpreting the Absolute Off-Market Pricing

Interpreting absolute off-market pricing requires understanding that it is a snapshot of value agreed upon by specific parties at a given moment, rather than a dynamic reflection of broader market sentiment. Since these transactions occur without public transparency, the price may not align perfectly with what might be considered fair market value in a more liquid environment.

When evaluating an asset purchased at an absolute off-market price, investors consider the rigor of the due diligence performed and the assumptions underlying the valuation methodologies used by both buyer and seller. The price reflects unique factors such as the urgency of the seller, the strategic interest of the buyer, specific deal terms, and the limited pool of potential participants. For illiquid assets, the absence of a competitive bid-ask spread means the agreed price is often a singular point of agreement rather than a range derived from active trading.

Hypothetical Example

Imagine a small, privately-held software company, "InnovateTech," which specializes in niche industrial automation solutions. InnovateTech is not publicly traded, and its shares are not regularly bought or sold. A larger technology conglomerate, "MegaCorp," expresses interest in acquiring InnovateTech to integrate its technology.

Instead of a public offering or stock market transaction, MegaCorp and InnovateTech engage in direct negotiation. InnovateTech's management hires a financial advisor who performs a discounted cash flow (DCF) analysis, projecting InnovateTech's future revenues and profits, considering its intellectual property and customer contracts. They also look at recent private acquisitions of similar, albeit not identical, software companies through comparable sales analysis.

After extensive due diligence by MegaCorp, and a series of back-and-forth discussions, they agree on a purchase price of $150 million for 100% of InnovateTech's equity. This $150 million represents the absolute off-market pricing for InnovateTech. It is a specific price agreed upon between the two parties, outside of any public trading venue, and reflects their assessment of the company's value under the negotiated terms of the acquisition.

Practical Applications

Absolute off-market pricing is a fundamental component of various financial activities, particularly in sectors dealing with assets that do not trade on public exchanges.

• Mergers and Acquisitions (M&A): Most private company acquisitions involve absolute off-market pricing. Buyers and sellers directly negotiate the terms and price of the transaction, which can include both equity and debt considerations.
• Private Equity and Venture Capital: Funds in these sectors acquire stakes in private companies. The entry and exit prices for these investments are typically determined through absolute off-market pricing, often involving complex valuation models and bespoke agreements.
• Real Estate Transactions: Large commercial real estate deals, private land sales, or unique properties often involve direct negotiations between parties, leading to an absolute off-market price rather than a price set by a broad public market.
• Illiquid Securities: Beyond private companies, this pricing applies to other illiquid assets such as certain debt instruments, derivatives, or collectibles, where no active public market exists.
• Regulatory Filings and Reporting: For private offerings, particularly those under SEC Regulation D, companies must determine the price at which they offer securities to accredited investors. While not a publicly traded price, this offering price is an example of absolute off-market pricing for new issuance⁵.

Regulators, such as the Financial Conduct Authority (FCA), have recently conducted reviews of private market valuation practices, underscoring the importance of robust governance and methodologies in determining these prices, especially as private markets continue to grow and attract wider investor interest⁴.

Limitations and Criticisms

Despite its necessity in private markets, absolute off-market pricing faces several limitations and criticisms. A primary concern is the inherent lack of transparency and liquidity compared to public markets. Without continuous trading and a broad pool of buyers and sellers, the agreed-upon price may not fully reflect a consensus fair market value. This can lead to challenges in accurately assessing the net asset value (NAV) of funds heavily invested in private assets.

One significant criticism centers on the potential for conflicts of interest in the valuation process. For instance, a fund manager's fees might be linked to asset valuations, creating an incentive to maintain higher marks, even if underlying conditions suggest a lower value³. The Financial Conduct Authority's review of private market valuations highlighted inconsistencies in applying valuation techniques and the need for stronger governance and independent review processes to mitigate such biases².

Furthermore, determining an absolute off-market price relies heavily on subjective inputs and assumptions within valuation models. While methods like discounted cash flow (DCF) and comparable sales analysis provide frameworks, the inputs for future cash flows, discount rates, and the selection of comparable transactions can introduce significant variability. This subjectivity means that even expert appraisals can lead to differing valuations, and there is no real-time market to validate the price. The absence of daily pricing in private markets means investors are often "always behind" on the current value of their investments, which can be a particular concern for retail investors gaining access to these markets¹.

Absolute Off-Market Pricing vs. Fair Market Value

Absolute off-market pricing refers to a specific, final price agreed upon in a private transaction, while fair market value is a broader concept representing the hypothetical price an asset would fetch in an open and competitive market between a willing buyer and a willing seller, with both having reasonable knowledge of relevant facts.

The key distinction lies in the determination process and context. Absolute off-market pricing is the actual price established through direct negotiation for a non-publicly traded asset. It is influenced by the specific circumstances, motivations, and bargaining power of the parties involved in that particular transaction. In contrast, fair market value is an estimated value, often derived from a theoretical market, and is typically used for accounting, tax, or legal purposes to determine a consensus valuation in the absence of an actual transaction. While those involved in an absolute off-market transaction will aim to arrive at a price close to their understanding of the fair market value, the agreed-upon off-market price may deviate due to unique deal terms, strategic considerations, or a lack of market efficiency.

FAQs

What types of assets commonly use absolute off-market pricing?

Absolute off-market pricing is common for illiquid assets such as shares in private companies, real estate properties sold privately, certain alternative investments like private debt, and unique collectibles where no organized public exchange exists for their trading.

How is an absolute off-market price determined?

An absolute off-market price is determined through direct negotiation between a buyer and a seller. This process is typically supported by comprehensive due diligence and the application of various valuation models, such as discounted cash flow analysis, comparable sales analysis, or asset-based valuation.

Is absolute off-market pricing less reliable than market pricing?

While absolute off-market pricing serves its purpose in private transactions, it can be less transparent and subject to greater subjectivity than market pricing from public exchanges. Public market prices reflect continuous supply and demand from a broad base of participants, whereas off-market prices are agreed upon by a limited number of parties, which can introduce biases and make external validation difficult.