What is Discount for Lack of Marketability in business valuation?

A discount for lack of marketability is a percentage reduction applied to business value that reflects the economic disadvantage of owning interests that cannot be sold quickly or easily. This valuation adjustment accounts for the illiquidity risk inherent in closely held business interests compared to publicly traded securities. Professional appraisers use empirical data from restricted stock studies and pre-IPO transactions to quantify these discounts, which typically range from 15% to 40% depending on company-specific factors.

Understanding DLOM is critical for business owners, CPAs, attorneys, and financial advisors involved in estate planning, tax compliance, litigation support, and transaction planning. David Hern CPA ABV ASA of Sofer Advisors explains that this discount directly impacts reported values for gift and estate tax purposes, buy-sell agreement pricing, and financial reporting requirements. Companies seeking fair market value assessments must consider how marketability constraints affect stakeholder decisions and regulatory compliance.

What factors influence marketability discounts?

Marketability discounts depend on several quantifiable factors that professional appraisers analyze systematically. Company size, financial performance, dividend policy, and industry characteristics all contribute to the magnitude of illiquidity adjustments applied to business valuations.

Key Factors Affecting DLOM Magnitude:

• Expected Holding Period – Longer periods until liquidity increase discount percentages
• Earnings Volatility – Unpredictable performance increases investor risk and discount levels
• Dividend Policy – Regular distributions reduce holding period cost and lower discounts
• Management Quality – Strong succession planning reduces company-specific risk
• Customer Concentration – Dependence on few customers increases risk premiums
• Regulatory Restrictions – Compliance requirements may limit transfer options

Empirical evidence from restricted stock studies shows discounts averaging 20-35% for public company securities with transfer restrictions. Pre-IPO studies demonstrate even higher discounts of 40-60% for private transactions compared to subsequent public offerings. These benchmarks provide foundational data for estimating marketability discounts in closely held business valuations, though company-specific analysis remains essential for defensible conclusions.

How do appraisers calculate DLOM percentages?

Professional business appraisers employ multiple methodologies to quantify discount for lack of marketability, combining empirical benchmarks with analytical models tailored to specific circumstances. The selection of appropriate methods depends on available data, intended use of the valuation, and applicable standards of value.

Primary calculation approaches include:

1. Restricted Stock Studies – Analyze discounts between restricted and freely tradable shares of identical public companies under SEC Rule 144 requirements
2. Pre-IPO Studies – Compare private transaction prices to subsequent public offering values for the same companies within months of going public
3. Option Pricing Models – Use Black-Scholes and other derivatives models to value the embedded put option representing marketability
4. Quantitative Marketability Discount Models – Apply discounted cash flow analysis incorporating expected holding periods and transaction costs
5. Guideline Transaction Analysis – Examine pricing differentials between strategic and financial buyer acquisitions of similar companies

Sofer Advisors maintains subscriptions to all major valuation databases, enabling comprehensive empirical analysis rather than relying on limited data sources. This approach ensures that DLOM calculations reflect current market conditions and withstand scrutiny from the IRS, courts, and other stakeholders. David Hern’s experience includes 11+ expert witness cases where defendable methodologies proved critical for successful outcomes.

What are common DLOM calculation mistakes?

Valuation practitioners frequently encounter challenges that can undermine the credibility and accuracy of marketability discount calculations. Understanding these pitfalls helps ensure proper application of professional standards and regulatory requirements.

Double-counting illiquidity represents the most significant error in DLOM analysis. This occurs when appraisers apply marketability discounts to base values that already reflect illiquidity constraints through distressed multiples or private company data. The IRS specifically warns against this practice in their technical guidance, emphasizing that DLOM should only apply when the underlying value represents a marketable interest.

Unsupported rule-of-thumb percentages create additional vulnerability during IRS examinations and litigation proceedings. Courts have rejected marketability discounts exceeding 30% in cases like Estate of Jephson where evidence demonstrated active buyer interest. Professional standards under USPAP and AICPA Statement on Standards for Valuation Services require empirical support for all adjustments to fair market value.

Misapplication of accounting standards presents particular challenges under IFRS 13 Fair Value Measurement and ASC 820. Grant Thornton guidance clarifies that only restrictions inherent in the financial instrument itself may affect fair value, excluding entity-specific limitations or pre-vesting conditions. This distinction significantly impacts equity-based compensation valuations and financial reporting requirements.

When does DLOM apply in different valuation contexts?

The application of discount for lack of marketability varies significantly across different legal and regulatory contexts, with specific standards governing when and how these adjustments may be applied. Understanding these contexts prevents inappropriate discount applications that could face challenge.

Estate and gift tax valuations frequently incorporate both discount for lack of control and discount for lack of marketability, following IRS guidelines that require separate analysis and proper sequencing. The IRS Job Aid on DLOM provides extensive case law showing courts accepting combined discounts ranging from 25% to 50% when supported by credible evidence. However, recent cases demonstrate increased scrutiny of excessive discount claims.

Shareholder dispute and statutory fair value proceedings often limit or prohibit marketability discounts entirely. New York courts have characterized DLOM in fair value cases as “an emperor without clothes,” arguing that minority shareholders should not bear the burden of illiquidity imposed by controlling shareholders. This creates significant differences in valuation conclusions depending on the legal standard applied.

Financial reporting under ASC 805 Purchase Price Allocation and ASC 718 Equity-Based Compensation requires careful consideration of marketability factors. While these standards don’t explicitly reference DLOM, they require fair value measurements that may incorporate illiquidity adjustments when consistent with market participant perspectives. Sofer Advisors has completed numerous financial reporting engagements where proper application of these standards proved essential for audit acceptance.

How has DLOM evolved with market changes?

The concept and application of discount for lack of marketability continues evolving as secondary markets expand and alternative liquidity sources emerge for private company interests. These market developments impact both the magnitude and applicability of marketability discounts in contemporary valuations.

Historical empirical studies from the 1980s and 1990s established DLOM benchmarks during periods of limited secondary market activity and restrictive securities regulations. Today’s environment includes expanded accredited investor definitions, crowdfunding platforms, and sophisticated secondary market makers that provide new liquidity alternatives for private company shareholders.

Technology platforms like Carta have operationalized 409A valuations incorporating DLOM for startup and venture-backed companies, creating standardized approaches for equity compensation planning. These developments don’t eliminate marketability discounts but may reduce their magnitude for companies with active secondary market participation or clear exit strategies.

Regulatory changes continue shaping DLOM applications across different contexts. The Tax Cuts and Jobs Act impacted estate planning strategies, while evolving SEC regulations affect restricted stock holding periods and transfer requirements. Professional appraisers must stay current with these developments to ensure compliance with applicable standards and maintain defensible valuation conclusions.

Frequently Asked Questions

What is a marketability discount?

A marketability discount is a percentage reduction applied to business value that reflects the economic disadvantage of owning interests that cannot be sold quickly, easily, or with certainty of price. This adjustment accounts for the illiquidity risk inherent in closely held business interests compared to publicly traded securities that can be sold immediately at quoted market prices.

What is a reasonable discount for lack of marketability?

Reasonable DLOM typically ranges from 15% to 40% based on empirical studies, though specific percentages depend on company-specific factors including size, profitability, dividend policy, and expected holding period. Restricted stock studies show average discounts of 20-35%, while pre-IPO studies demonstrate higher discounts of 40-60%. Professional appraisers must support any discount with credible evidence and analysis.

What are the three types of discounts?

The three primary valuation discounts are discount for lack of control, discount for lack of marketability, and key person discount. Discount for lack of control reflects the inability to direct company operations and strategy. Discount for lack of marketability addresses illiquidity and transfer restrictions. Key person discount accounts for dependence on specific individuals critical to business operations and success.

What does a 20% discount rate mean?

A 20% discount rate in DLOM context means the appraiser has reduced the pro rata share value by 20% to account for marketability constraints. For example, if a 10% interest has a pro rata value of $100,000, a 20% DLOM would result in a concluded value of $80,000. This adjustment reflects the economic cost of illiquidity borne by the interest holder.

How do you calculate discount for lack of marketability?

DLOM calculation involves analyzing empirical data from restricted stock studies, pre-IPO transactions, and option pricing models. Appraisers consider company-specific factors including expected holding period, dividend policy, financial performance, and market conditions. Professional DLOM analysis typically costs $5,000 to $15,000 as part of a comprehensive business valuation engagement. The calculation requires professional judgment to synthesize multiple data sources and analytical approaches into a supportable discount percentage that reflects market participant behavior.

What is the difference between DLOM and DLOC?

DLOM addresses marketability and liquidity constraints, while DLOC reflects the inability to control company operations and strategic decisions. These discounts address different risk factors and may both apply to minority interests in closely held companies. Professional standards require separate analysis and documentation of each discount to avoid double-counting and ensure proper application of valuation theory.

When should DLOM not be applied?

DLOM should not apply when the base valuation already incorporates illiquidity through private company data or distressed multiples, when dealing with controlling interests in certain contexts, or when applicable legal standards prohibit marketability adjustments. IFRS 13 limits adjustments to instrument-specific restrictions, while some shareholder dispute cases exclude DLOM to protect minority rights.

What empirical data supports DLOM calculations?

Empirical support comes from SEC restricted stock studies showing discounts averaging 20-35% for identical securities with transfer restrictions, pre-IPO studies demonstrating 40-60% discounts between private transaction prices and subsequent public offerings, and option pricing model calibrations. Professional appraisers rely on multiple studies and analytical approaches to ensure credible and defensible discount conclusions.

How does company size affect marketability discounts?

Larger companies typically command lower marketability discounts due to broader buyer appeal, improved access to capital markets, and reduced transaction costs relative to deal size. Smaller companies face higher discounts reflecting limited buyer pools, higher transaction costs, and increased due diligence requirements. However, company-specific factors including profitability, growth prospects, and market position significantly influence discount magnitude regardless of size.

What role does DLOM play in estate planning?

DLOM significantly impacts estate and gift tax valuations by reducing reported values of closely held business interests transferred to family members. Combined with discount for lack of control, total discounts of 25-50% are common in estate planning contexts. However, the IRS scrutinizes large discounts and requires credible empirical support for all valuation adjustments applied to transferred interests.

What Should You Do Next?

Discount for lack of marketability represents a critical component of business valuation that directly impacts tax planning, transaction pricing, and regulatory compliance. Understanding when and how these adjustments apply ensures accurate valuation conclusions that withstand professional scrutiny and serve your strategic objectives effectively.

Contact Sofer Advisors—backed by 180+ five-star Google reviews and Inc. 5000 recognition (2024, 2025)—to discuss your specific valuation needs and learn how our team of credentialed professionals can provide defendable analysis tailored to your circumstances. Schedule a consultation to explore how proper application of marketability discounts can optimize your estate planning, transaction structuring, or compliance requirements.

This content is for informational purposes only and does not constitute professional valuation advice. Business valuation conclusions depend on specific facts and circumstances. Contact Sofer Advisors for a consultation regarding your specific situation.