Discount for Lack of Marketability Explained

The discount for lack of marketability (DLOM) is a reduction applied to the value of a private company share to account for its illiquidity—the fact that it cannot be instantly sold at market prices. Private shares are worth less than identical public shares because they lack a ready buyer, exit windows are long and uncertain, and trading restrictions apply.

Why private shares trade at a discount

An investor who owns 1% of a public company can sell that stake in seconds at the market price. Transaction costs are minimal; the buyer pool is enormous. An investor who owns 1% of a private company has none of these luxuries. There is no public market. Finding a buyer takes months or years. Restrictive shareholder agreements may forbid sales. Due diligence demands are onerous. Discounts and earn-outs chip away at proceeds.

The discount for lack of marketability captures this friction. If a public company worth $100 per share is worth $70 per share as a private firm, the 30% difference is the DLOM—the liquidity penalty.

This discount is real and measurable. Private equity sponsors buy minority stakes at DLOM-adjusted prices. Employees receive options and restricted stock units at DLOM-discounted values for tax purposes. Estate planners apply DLOM to calculate taxable value of closely held shares. Without a consistent, empirically grounded DLOM, valuations become arbitrary.

Historical basis: restricted stock studies

The most cited source of DLOM research is restricted stock studies, pioneered in the 1990s. A restricted stock is a share of a public company that cannot be sold for a defined lockup period—often 1–3 years. These shares trade at a discount to the unrestricted public price because the buyer must wait to liquidate.

Early studies (e.g., Emory, Trout) compared restricted stock prices to the contemporaneous public price. Results typically showed a 25–35% discount for a 2-year restriction. This became a baseline for private company DLOM: if a public share is worth 100 and a restricted 2-year share is worth 70, then a private share with a 3–5 year liquidity horizon should be worth 50–60.

However, restricted stock studies have limitations. Restricted stockholders know they will be able to sell after the restriction lapses; private shareholders have no such guarantee. A private company could be worthless in 10 years, or acquisition-ready in 18 months. The uncertainty is not fully captured by a static restriction date.

Modern methods: put/call parity and option pricing

A more sophisticated approach treats illiquidity as a real option. The private shareholder has a “put option” embedded in their stake: the right to force a sale or liquidation at some minimum value, but with a long and uncertain exercise date.

Using option pricing models (Black-Scholes, binomial), appraisers can model the value of that embedded put. Assumptions include:

• Probability of liquidity event (acquisition, IPO, recapitalization) within X years
• Time to liquidity (probability distribution: could be 3 years, 7 years, or never)
• Volatility of private firm value (typically 30–50% annualized for a private company)
• Risk-free rate and required return

The model then solves for the DLOM that equates the private share value to the public share value minus the option cost.

Example: A private software firm is valued at $100 per share on a revenue multiple. Applying option-pricing logic:

• 60% probability of exit within 5 years at $120 per share
• 30% probability of exit in 5–10 years at $80 per share
• 10% probability of no liquidity (becomes worthless)
• Volatility: 40% per annum

The model calculates that the embedded put—the cost of illiquidity and timing risk—reduces the share value by 28%. So $100 becomes $72.

SEC Form 10 and Rule 10b5-1 holding periods

The U.S. Securities and Exchange Commission provides empirical guidance on lockup periods. SEC Rule 10b5-1 requires insiders to wait 6 months after a public company exit before selling shares. Studies of this holding period—comparing share prices at the IPO lock-up expiry to public prices immediately before—show discounts of 15–25% for that 6-month restriction.

The SEC has also studied trading volumes and bid-ask spreads for thinly traded public shares (micro-cap, illiquid exchange-traded stocks). These stocks trade at discounts of 5–15% compared to large-cap equivalents, capturing the cost of finding buyers and higher trading friction.

These data points inform DLOM for private companies: a 6-month lock translates to roughly 15–20% DLOM; a 3-year lockup to 30–40%; a 7-year lockup to 40–50%.

Factors that adjust DLOM up or down

Increases DLOM (larger discount):

• Early-stage company with uncertain path to liquidity
• Illiquid industry (e.g., private healthcare practices, family-owned industrial manufacturers)
• Heavy reliance on a single customer or founder
• Debt covenants or contingent obligations that constrain sale timing
• Minority stake (no control; easier to ignore outside pressure)
• Long historical average time to liquidity (venture capital funds show 7–10 year average exits)

Decreases DLOM (smaller discount):

• Near-term acquisition or IPO announced (liquidity event < 1 year)
• Dividend-paying, cash-generative business with known buyer interest
• Controlling stake (holder can force a sale or restructuring)
• Large revenue base and clear path to profitability
• Younger company in a hot sector with rapid consolidation (e.g., fintech, biotech in boom years)

Magnitude and typical ranges

For a typical private company with a 3–5 year expected exit horizon:

• DLOM: 25–35%

For high-growth or near-exit scenarios:

• DLOM: 15–25%

For illiquid, uncertain, or distressed situations:

• DLOM: 40–60%

The DLOM should never exceed 100% (that would make the private share worthless, which is only appropriate in insolvency scenarios). It also should never be negative (the discount cannot add value).

Large institutional investors (private equity funds, venture capital) negotiate around DLOM by using it as a bargaining tool. If the market DLOM is 30%, a PE sponsor might acquire a 20% minority stake at a 40% discount—paying less than the DLOM-adjusted price—to account for the lack of control and their own execution risk. The gap between market DLOM and negotiated purchase discount is where deals are made.

Regulatory and tax applications

ESOP Valuations: If a company sponsors an employee stock ownership plan, the plan trustee must value shares for contribution and distribution. DLOM is standard; typical values are 25–35%.

Estate & Gift Tax: When an owner dies, heirs must report the taxable value of their inherited shares. The IRS accepts DLOM-adjusted valuations if supported by a competent appraisal. Discounts of 25–40% are routine; the IRS scrutinizes larger discounts.

Financial Reporting: Under ASC 606 and other accounting standards, companies must value equity issued to employees using fair value methods. This often includes a DLOM.

Litigation & Disputes: In divorce settlements, shareholder disputes, or breach-of-contract litigation, courts rely on appraisals that apply DLOM. A 30% discount can swing a $10M valuation by $3M.

Practical limitations and controversies

The DLOM is a point-in-time estimate. Conditions change. A tech startup’s DLOM drops from 35% to 15% after a strong funding round from Sequoia. A manufacturing firm’s DLOM jumps from 20% to 45% after the loss of its largest customer.

The empirical base is limited. Restricted stock studies are old (1990s–2000s) and relied on smaller sample sizes. Modern private equity, secondary markets, and secondary sales of late-stage private shares have expanded the empirical base, but methodological debates persist about whether restricted stock benchmarks apply equally to all private companies.

DLOM can be manipulated. An appraiser who wants to minimize taxable value might apply a 45% DLOM with loose justification. An appraiser hired by management to justify high stock option grants might apply a 15% DLOM. Courts and auditors have become more skeptical; appraisals must now include detailed written support for DLOM assumptions.

See also