The Discount for Lack of Marketability, or DLOM, is a discount applied to a company’s value when an ownership interest cannot be converted to cash quickly, and free of excessive expenses. Companies that would otherwise struggle to sell shares or ownership may apply a discount to make the business more attractive to a potential buyer.
As an example, your shares of Apple stock would sell quickly, and are easily converted to cash. Because Apple is a well-known, profitable, and respected company, its shares are highly marketable. Conversely, interests in private businesses are much more difficult to sell.
Selling ownership in a private sector business is more difficult because there is usually no willing buyer for them, making shares less liquid. Instead, when selling a private company, business owners should expect considerable time, effort and expense, as documentation must be assembled, intermediaries must be found, and sales must be negotiated and closed. It’s because of these issues that small as well as medium-size businesses are not “liquid,” and a discount is often applied to their value.
Determining the Discount for Lack of Marketability
Although there is no one way to measure what a discount for lack of marketability should be, there are two common approaches for calculating the discount for a small, medium, and/or privately-held business. The first is to compare the sale price of restricted stock of similar public companies to the sale price of unrestricted stock of the same company. Doing so helps determine the discount for lack of restricted marketability.
The second method is to compare the price of a company’s private stock sale transactions with the discounted public stock prices offered in its IPO shortly thereafter.
Components of the Discount for Lack of Marketability
Risk and return – An investment’s risk and return profile is determined largely by if and when dividends are paid, how long an interest will be owned, and how retained earnings will be reinvested – among other factors.
One-time transaction costs – When private businesses are sold, owners must factor in legal fees, brokerage fees, accounting fees, and other one-time costs.
Time value of money – It may take several years to sell a private business, creating an opportunity cost for investors forced to hold on to an illiquid investment.
Unique circumstances – Other unique circumstances may make a business unmarketable. An example is a bad reputation, recent controversy, or problems with real estate. These issues will factor into a business’s ability to sell ownership and impact any need to discount the sale price.
Shareholder complexities – It is generally more attractive for a company to have a single shareholder, rather than multiple shareholders – regardless of the percentage of ownership. Shareholder disagreements and disputes can be costly and time consuming, especially in the sale of a private business. Also, simply the presence of multiple shareholders in a closely-held business erodes the likelihood of achieving a quick sale because it may be difficult for the shareholders to reach agreement over the terms proposed by a willing buyer.
Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.