By Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services
[email protected]
What is a Discount for Lack of Marketability (DLOM)?
According to the International Glossary of Business Valuation Terms, Marketability is the ability to quickly convert property to cash at minimal cost. If an ownership interest lacks that ability, a DLOM is the amount or percentage deducted from the value to reflect the relative absence of marketability.
Depending on what valuation method is used, a DLOM can be critical to assigning a value to a company or asset.
In valuing a privately held ownership interest (either partial equity interest or 100% equity interest) the adjustment to the value of the private enterprise to reflect its estimated marketability must consider many factors and there are no “rules of thumb.” It takes the experience of the valuation analyst, along with supporting specific analysis of the pertinent data, to apply professional judgement in estimating the appropriate marketability of the subject interest valued.
The Internal Revenue Service (IRS) uses a Job Aid in applying DLOM to valuation analysis. Given two identical business interests, an investor will pay a higher price for a business that could be converted to cash quicker. Alternately, that investor will pay a lower price for a business that cannot be converted to cash quickly without the risk of loss in value.
How can DLOM be determined?
Using the IRS Job Aid as a guide, the following factors influence a property’s marketability:
- Value of subject corporation’s privately traded securities vs. its publicly traded securities
- Dividend-paying (or distribution) ability and history
- Dividend yield
- Attractiveness of subject business
- Attractiveness of subject industry
- Prospects for a sale or public offering of the company
- Number of identifiable buyers
- Attributes of controlling shareholder, if any
- Availability of access to information or reliability of that information
- Management
- Earnings levels
- Revenue levels
- Book to market value ratios
- Information requirements
- Ownership concentration effects
- Financial condition
- Percent of shares held by insiders
- Percent of shares held by institutions
- Percent of independent directors
- Listing on a major exchange
- Active vs. passive investors
- Registration costs
- Availability of hedging opportunities
- Market capitalization rank
- Business risk
- Subject Interest Factors
- Restrictive transfer provisions
- Length of the restriction period
- Length of expected holding period
- Offering size as a percentage of total shares outstanding
- Registered vs. unregistered
- General economic conditions
- Prevailing stock market conditions
- Volatility of stock
There are studies and methods that have been developed to help valuation analysts determine DLOM. These include the Benchmark Method, the Quantitative Marketability Discount Model, The Pre-IPO Approach, Hedging Models, Comparative Analysis with Restricted Stock Approach, the Bajaj Method, the Burns Method and the FMV Method.
Ultimately, after assessing the marketability factors and whatever valuation method the analyst employs, determining DLOM can still be a judgment call that requires the keen eye of an expert. Calculating DLOM incorrectly can lead to great variations in the potential sale price of a business or other property.
If you have further questions about DLOM or any other valuation issue, please contact Amber Hoover at (317) 613-7844 or [email protected].