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What Does Discounts for Lack of Marketability Mean?
Discounts for Lack of Marketability (DLOM) refer to the valuation difference between publicly traded stocks and privately held shares with limited tradability. Key methods to quantify DLOM include the restricted stock, IPO, and option pricing methods. Understanding these discounts is crucial for valuing noncontrolling interests in privately held companies, especially in tax-related valuations.
Key Takeaways
- Discounts for Lack of Marketability (DLOM) are used to determine the value difference between public and privately held stock.
- DLOM is often calculated using methods such as restricted stock, IPO, and option pricing approaches.
- DLOM challenges arise in tax disputes and valuation of nonmarketable ownership interests.
- Selling privately held company shares is generally more costly and time-consuming than publicly traded shares.
- The typical DLOM range, according to studies, is between 30% to 50%.
How DLOM Impacts Valuations
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%.
Challenges in Applying DLOM
Noncontrolling and nonmarketable ownership interests in closely held companies present unique challenges for valuation analysts. These issues often arise with gift, estate, and generation-skipping transfer taxes, as well as with income, property, and other tax disputes.
These issues often arise during gift tax, estate tax, generation-skipping transfer tax, income tax, property tax and other taxation disputes. To help valuators, the Internal Revenue Service (IRS) provides guidance, especially on two related issues: 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 where the owner can quickly achieve liquidity is worth more than one that cannot be sold fast. Thus, privately held companies should be sold at a discount to their intrinsic value due to extra costs, uncertainty, and longer sales processes.
The Bottom Line
Discounts for Lack of Marketability (DLOM) are crucial for valuing noncontrolling, nonmarketable ownership interests in closely held companies. By quantifying the difficulty of selling these investments, DLOM accounts for the reduced value compared to publicly traded stocks. Various methods, like the restricted stock and IPO methods, help determine these discounts, which typically range from 30% to 50%. Valuation analysts face challenges due to taxes and marketability issues, but understanding DLOM aids in accurately assessing investment worth. Always consider the implications of liquidity and control when evaluating these types of holdings.
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