Key Takeaways
- DLOM discounts value for illiquidity risk.
- Private shares sell slower than public ones.
- Typical DLOM ranges from 15% to 60%.
- Methods include restricted stock and pre-IPO analyses.
What is Understanding Discounts for Lack of Marketability (DLOM) in Valuation?
The Discount for Lack of Marketability (DLOM) is a reduction applied to the valuation of privately held business interests or restricted stock to reflect their illiquidity compared to publicly traded securities. This discount accounts for the difficulty and extended period required to convert such assets into cash at minimal cost, distinguishing it from concepts like illiquid assets more broadly.
DLOM complements other valuation adjustments such as discounts for lack of control, ensuring the fair market value reflects real-world market conditions.
Key Characteristics
Understanding the core features of DLOM helps clarify its impact on valuation.
- Illiquidity Adjustment: Reflects economic disadvantage due to restricted transferability or absence of a public market.
- Typical Range: Discounts commonly range from 15% to 40%, depending on company specifics and market conditions.
- Application Contexts: Used in estate valuations, shareholder disputes, and buy-sell agreements where marketability is limited.
- Methodologies: Calculations often rely on restricted stock studies, pre-IPO comparisons, or option pricing models.
- Time Horizon: Longer expected holding periods generally increase the DLOM percentage.
How It Works
DLOM quantifies the value reduction for securities that cannot be quickly sold like publicly traded shares. Valuations often start with a discounted cash flow (DCF) model based on public comparables, then adjust downward to account for marketability constraints.
Appraisers analyze empirical data such as price differences between restricted and unrestricted shares or pre- and post-IPO transactions. Option pricing models treat the inability to sell immediately as a put option, estimating the cost of illiquidity precisely. Factors like dividend yield, volatility, and holding period all influence the final discount.
Examples and Use Cases
DLOM is applied across various sectors where private or restricted securities are valued.
- Airlines: Shares of companies like Delta often require DLOM adjustments when not publicly tradable or restricted.
- Fixed Income: Bonds without active secondary markets, similar to those found in bond funds, may also reflect illiquidity discounts.
- Equity ETFs: Even broadly traded instruments like IVV offer context for liquidity standards used in marketability assessments.
Important Considerations
When applying DLOM, it is critical to support the selected discount with robust evidence to withstand regulatory scrutiny, especially from the IRS. Overstating the discount can lead to challenges in tax or legal proceedings.
Valuers should integrate DLOM carefully with other valuation adjustments to avoid double-counting risks. Understanding the nuances of your specific asset and market conditions will guide appropriate discount selection and ensure alignment with investment valuation standards.
Final Words
Discounts for Lack of Marketability reflect the real costs and risks of illiquidity in private valuations, typically ranging from 15% to 40%. To ensure accuracy, carefully assess company-specific factors and consult valuation experts when applying DLOM in your financial analysis.
Frequently Asked Questions
DLOM is a percentage reduction applied to the value of a privately held business interest or restricted stock to account for its illiquidity, meaning it cannot be quickly sold or converted to cash like publicly traded securities.
DLOM is applied because private company interests lack a ready market, leading to higher risk, longer holding periods, and uncertainty in sale price, which buyers factor into a lower valuation compared to public stocks.
Typical DLOM ranges vary by context: restricted stock studies show 20-35%, pre-IPO studies range from 40-60%, and general private firms fall between 15-40%, depending on company-specific factors.
Appraisers use methods like the Restricted Stock Method, Pre-IPO Method, and Option Pricing Models to estimate DLOM, combining data to reach a supportable discount for illiquidity.
Factors include the company’s size, profitability, dividend policy, expected holding period, market conditions, and specific transfer restrictions that affect liquidity.
DLOM is critical in estate and gift tax valuations, shareholder disputes, and buy-sell agreements where fair market value must reflect the real-world difficulty of selling private interests.
DLOM reflects the reduced value due to illiquidity and inability to quickly sell, while DLOC accounts for the inability to direct company operations; both are applied separately in valuation.
Unsupported DLOM discounts can face IRS challenges, so professional appraisers ensure discounts are based on credible studies and company-specific data to withstand scrutiny.
