The Discount for Lack Of Marketability (DLOM)

The difference in price an investor will pay for a liquid asset compared to a comparable illiquid asset is often substantial and one of the largest components in a valuation adjustment. The measurement of the DLOM continues to be a controversial topic especially with regard to valuations performed for gift and estate tax, shareholder litigation, buy-sell agreements, and family law purposes.

There are varying degrees of marketability. In the United States public capital markets, a security owner can sell an actively traded security over the telephone or internet and typically receive the proceeds, net of a small transaction cost, within three business days. The other extreme is represented by a hypothetical private business that pays no dividends or distributions, requires periodic capital contributions, has significant risk factors related to management depth and concentrations in customers, and places restrictions on subsequent ownership transfers.

There are other characteristics of a closely held entity that further impair marketability; the population of potential buyers of a closely held entity is much smaller than the population of buyers of a publicly traded entity; a minority shareholder is unable to register closely held shares for public trading, and; banks are typically unwilling to accept closely held stock as collateral as they would accept publicly traded shares.

Empirical evidence indicates that the DLOM for closely held securities is within a range of 25% to 50% compared to publicly traded securities. However, the specific facts and characteristics of each security and the specific company will determine the magnitude of the DLOM.

In Bernard Mandelbaum v. Commissioner (T.C. Memo 1995-255, June 12, 1995) Judge Laro raised 10 key factors to be considered in determining an appropriate DLOM.

These are:

1. Private vs. public sales of the subject company stock or stock sales of similar public companies.

2. An analysis of the subject company's financial statements.

3. The subject company's dividend policy.

4. The nature of the subject company, its history, position in the market, and economic outlook.

5. The subject company's management.

6. Degree of control transferred with the block of stock to be valued.

7. Any restrictions on the transferability of the subject company stock.

8. Period of time an investor mush hold stock to realize a sufficient profit.

9. The subject company’s redemption policy.

10. Costs associated with making a public offering.

A strong valuation report presents a convincing and detailed argument of the actual factors that impact marketability and are unique to each situation.