Understanding Discounts for Lack of Marketability (DLOM) in Valuation

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Understanding Discounts for Lack of Marketability (DLOM) in Valuation

Discounts for Lack of Marketability (DLOM) reflect the reduction in value applied to ownership interests that cannot be readily sold in public markets. They are essential when valuing noncontrolling, privately held shares because such interests are generally harder, slower, and more costly to convert into cash than publicly traded stock.

Key points

  • DLOM measures the price reduction for limited tradability or liquidity of an ownership interest.
  • Common valuation approaches: restricted stock, IPO-comparison, and option-pricing methods.
  • Empirical studies commonly find DLOM estimates in the range of about 30%–50%, though results vary by situation and evidence.
  • DLOM is distinct from discounts for lack of control (DLOC) but both may apply to privately held interests.
  • DLOM is frequently contested in tax, estate, and other valuation disputes; thorough documentation and method selection are critical.

Common methods to estimate DLOM

  1. Restricted stock method
  2. Compares prices of freely traded shares to restricted (nontransferable) shares of the same or similar issuers.
  3. The observed price gap is attributed to lack of marketability.

  4. Requires careful matching for company size, industry, and other control-related factors.

  5. IPO method

  6. Compares pre-IPO share prices (or prices paid by insiders/pre-IPO buyers) to post-IPO market prices.
  7. The percentage difference between pre- and post-IPO prices is used as the DLOM estimate.

  8. Works best when comparable IPOs are available and when lock-up periods and other constraints are considered.

  9. Option-pricing method

  10. Uses option prices to infer the value of an ability to sell (liquidity option).
  11. The option premium relative to the strike can be interpreted as the marketability value.
  12. Requires assumptions about volatility, time horizon, and appropriate option structures; more model-dependent than empirical-comparison methods.

Typical magnitudes and evidence

Studies and market observations often suggest DLOM estimates commonly fall in the 30%–50% range for many privately held, noncontrolling interests. However, the appropriate discount for any specific valuation depends on facts and circumstances—such as the expected time to sale, transaction costs, transfer restrictions, and the pool of potential buyers.

Challenges and practical considerations

  • Distinguishing marketability from control: DLOM addresses liquidity/transferability; DLOC addresses the absence of decision-making authority. Both can apply, but they should be quantified and supported separately.
  • Data availability: Reliable restricted-stock or IPO comparables may be limited, especially for smaller or unique businesses.
  • Model sensitivity: Option-based approaches can be highly sensitive to volatility and time-horizon assumptions.
  • Tax and litigation scrutiny: DLOM is frequently disputed in gift, estate, and other tax contexts—clear documentation of method choice and empirical support is essential.
  • Transaction realities: Selling a private interest typically involves broker fees, deal negotiation, limited buyer pools, and longer timelines—all justificatory factors for a discount.

Best-practice guidance

  • Select the valuation method(s) that best match available data and the economic facts of the interest being valued.
  • Where feasible, apply multiple methods and reconcile results rather than relying on a single technique.
  • Document assumptions, comparable selections, and adjustments (e.g., for size or control differences).
  • Separate marketability and control analyses to avoid double-counting discounts.
  • Consider transaction costs, lock-up periods, expected liquidity horizon, and buyer-market depth when setting the discount.

Bottom line

DLOM quantifies how limited tradability reduces the value of privately held or restricted ownership interests relative to publicly traded stock. Analysts should choose empirically supported methods, document assumptions carefully, and treat marketability and control as distinct valuation issues. Typical discounts often fall in the 30%–50% range, but the correct figure depends on specific facts, market evidence, and the chosen valuation approach.