Discount for Lack of Marketability

A discount for lack of marketability (DLOM) reduces the value of a privately held business stake below what an identical public-company share would fetch, because private shares cannot be sold quickly or easily. The discount acknowledges the real economic cost of illiquidity.

Why private shares are worth less

If you own 100 shares of a public company trading at $50, you can sell them before the market closes today and hold the cash tomorrow. The transaction is frictionless, the price is discoverable, and your cost is minimal (a small bid-ask spread and a brokerage commission).

If you own an equivalent stake in a private company—say, $5,000 worth by comparable earnings and assets—selling it is a months-long ordeal. You must find a buyer (or multiple buyers), negotiate terms, get board or shareholder approval if required, sign a purchase agreement with reps and warranties, and wait for funds. During that time, your money is still trapped in an illiquid asset. If the company falters or the owner dies, the timing of that forced sale could be terrible.

This illiquidity has economic value. In finance, illiquidity is a cost, and assets that impose that cost are worth less. A investor paying $5,000 for a private stake is, in effect, paying for a position she cannot easily exit. That’s worth something—a discount is appropriate.

The discount for lack of marketability quantifies this. It says: “The fundamentals of this private stake are worth, say, $10,000 (based on comparable earnings or assets). But because you cannot readily sell it, you should pay less. Apply a 30% DLOM, and the fair price is $7,000.”

How the discount is estimated

There is no single formula for DLOM. Appraisers use several methods, often triangulating among them.

Comparable restricted-stock studies: The most common approach looks at the prices paid in private transactions for restricted shares of public companies or for stakes in companies that recently went public. In the months before an IPO, shares might trade at a 20–40% discount to the IPO price; that gap reflects the illiquidity and risk of pre-IPO holdings. Similarly, restricted stock (shares subject to SEC lockup periods) trades at a discount to unrestricted shares of the same company. These studies provide empirical benchmarks.

Option-pricing models: Some appraisers use variants of the Black-Scholes model to estimate the cost of illiquidity. If an investor knows she cannot sell for, say, 5 years, the model can estimate the value of that lost optionality. The approach is theoretically elegant but relies on assumptions about the probability and timing of a liquidity event.

Holding-period analysis: A simpler method estimates how long the investor might reasonably expect to hold the stake before a sale, IPO, or other exit event. Longer expected holding periods justify larger discounts. A founder of a venture-backed startup might expect liquidity in 5–7 years; the discount could be 25–35%. A minority shareholder in a stable private family business might never see liquidity; the discount could be 40–50%.

Lack of marketability vs. restricted-stock trading patterns: Appraisers also look at how thinly traded private securities move. If a company has $10 million in value but no active secondary market, the last trade might have occurred years ago at a price now irrelevant. The absence of price discovery itself is a cost.

Appraisers typically estimate DLOM in the 20–50% range, with most private stakes landing in the 25–40% band. Factors that increase the discount include small firm size, tight transfer restrictions, concentrated ownership, and lack of any clear exit path. Factors that lower it include recent successful comps (showing investors have bought in at known prices), a large and stable ownership base, and clear potential paths to liquidity.

Where the discount appears in practice

Estate and gift planning: Executors and appraisers can apply DLOM when valuing private business interests for estate tax purposes. If an estate claims that a $10 million business should be valued at $6 million (with a 40% DLOM), the estate tax is calculated on $6 million. This significantly reduces tax owed. The IRS scrutinizes such discounts—they must be supported by market data and reasonable assumptions—but DLOM is well-established in tax law.

M&A transactions: In acquisitions, buyers often implicitly apply a DLOM by offering prices lower than what they might pay for a controlling stake in a similar public company. This is not always explicit (“apply 30% DLOM”), but the negotiation reflects the reality that seller may struggle to find alternative buyers.

Financing and collateral: When a bank values a private company for lending purposes, it may apply a DLOM to determine the amount available to borrow against. A $10 million business might offer only $6–7 million in collateral due to illiquidity concerns.

Employment agreements and equity plans: Startups granting equity to employees must valuate that equity for tax and accounting purposes. DLOM is commonly applied, because employee shares vest over years and cannot be sold until a liquidity event (IPO or acquisition). The discount reflects the real economic reality that employees are accepting less liquid compensation.

Co-owner buyouts: When a minority partner buys out a co-owner’s stake, or when a business is being dissolved, the purchase price often reflects both a minority discount (for lack of control) and a DLOM (for illiquidity). The two discounts compound: a 25% minority discount and a 30% DLOM yield a combined 47.5% reduction from the pro-rata value of a 100% controlling stake.

DLOM vs. the minority discount: a critical distinction

It is easy to confuse DLOM with the minority discount, but they address different risks.

The minority discount reflects the fact that a 10% stake in a company gives you no control. You cannot force dividends, cannot block unfavorable decisions, and have limited voting rights. A 10% stake is worth less than 10% of the value of a 100% controlling interest because the controlling shareholder can extract disproportionate value or behave oppressively.

The DLOM (discount for lack of marketability) reflects the fact that your stake, whether minority or controlling, cannot be easily sold. A controlling stake is worth more than a minority stake (no minority discount), but even a controlling stake of a private company faces liquidity friction. If you own 100% of a private company worth $10 million, you still cannot instantly convert it to $10 million in cash; you must sell the whole business or find an investor. That friction warrants a DLOM.

A well-structured valuation applies both discounts separately, reflecting both control and liquidity, when appropriate.

When DLOM doesn’t apply—or shouldn’t

DLOM is not appropriate in every context. If a business has a clear, imminent path to liquidity—a signed letter of intent for acquisition, or a company preparing for IPO with a committed underwriter—DLOM should be zero or minimal. Similarly, if a private company has an active secondary market (shares trading among investors regularly), the lack of marketability is less acute.

In some cases, a put option or call option agreement grants shareholders the right to sell back their shares at a predetermined price, effectively guaranteeing liquidity. Such protections reduce or eliminate DLOM.

Courts have also rejected DLOM in contexts where shareholders had no reasonable expectation of liquidity (e.g., shares given to a child in a family operating company), or where applying DLOM would produce an absurdly low valuation. The discount must be grounded in economic reality, not used as a way to escape taxes or fair division.

Practical guidance

When evaluating a private stake, ask:

1. How likely is a liquidity event? If an exit is expected in 2–3 years, DLOM might be 15–25%. If it’s 10+ years, or never, DLOM could be 35–50%.
2. Are there transfer restrictions? If shareholders have drag-along rights or put/call agreements, DLOM is lower.
3. What do recent comparables show? If investors have recently bought stakes at known prices, use those as benchmarks.
4. Is the business stable and profitable? A growing, profitable private company merits a smaller DLOM than a struggling one, because the exit path is clearer.

The discount for lack of marketability is not a fudge factor; it is a real economic penalty for illiquidity, grounded in market evidence and justified by the friction of selling a private stake.

See also