What Does Discounts For Lack Of Marketability Mean?

Discounts for lack of marketability (DLOM) refer to the method used to help calculate the value of closely held and restricted shares. The theory behind DLOM is that a valuation discount exists between a stock that is publicly traded and thus has a market, and the market for privately held stock, which often has little if any marketplace. 

Various methods have been used to quantify the discount that can be applied including the restricted stock method, IPO method, and the option pricing method.

Understanding Discounts For Lack Of Marketability (DLOM)

The restricted stock method purports that the only difference between a company's common stock and its restricted stock is the lack of marketability of the restricted stock. 

Subsequently, the price difference between both units should arise due to this lack of marketability. The IPO method relates to the price difference between shares that are sold pre-IPO and post-IPO. The percent difference between the two prices is considered the DLOM using this method. The option pricing method uses the option's price and the strike price of the option as the determinants of the DLOM. The option price as a percentage of the strike price is considered the DLOM under this method. The consensus of many studies suggests that the DLOM ranges between 30% to 50%.

Discounts For Lack Of Marketability Challenges

Noncontrolling, nonmarketable ownership interests in closely held companies pose some unique challenges for valuation analysts. These issues often arise during gift tax, estate tax, generation-skipping transfer tax, income tax, property tax and other taxation disputes. To assist valuators in the field, the Internal Revenue Service (IRS) offers some guidance, particularly around two related issues that further cloud analysis: Discount for Lack of Liquidity (DLOL) and Discount for Lack of Control (DLOC).

Without question, selling an interest in a privately held company is a more costly, uncertain and time-consuming process than liquidating a position in a publicly traded entity. An investment in which the owner can achieve liquidity in a timely fashion is worth more than an investment in which the owner cannot sell the investment quickly. As such, privately held companies should sell at a discount to actual intrinsic value because of additional costs, increased uncertainty and longer time horizons tied to selling unconventional securities.