Discount for Lack of Marketability: Uses and Calculation

Not all assets can be sold quickly or easily. A minority stake in a family business, restricted stock or an ownership interest in a private company may have significant value on paper but be difficult to convert into cash. That’s where a discount for lack of marketability (DLOM) comes into play. By accounting for the costs, delays and uncertainty associated with selling illiquid assets, a DLOM helps valuation professionals arrive at a more realistic estimate of fair market value.

If you’re valuing a private business interest, planning an estate or preparing to transfer wealth to future generations, a financial advisor can help you evaluate how marketability discounts may affect taxes, valuations and long-term planning decisions.

What Is a Discount for Lack of Marketability?

A discount for lack of marketability (DLOM) is a reduction to the value of an asset or business interest. It accounts for the difficulty or expense of selling it quickly.

Think of it this way: a publicly traded stock you can sell in seconds through your brokerage account is far more valuable than an identical ownership stake in a private company that could take months or years to convert to cash.

The DLOM quantifies this difference. It recognizes that not all assets are equally liquid or easy to sell.

For most investors, the DLOM becomes relevant when dealing with non-public securities, private business stakes or restricted shares in public companies. When you own a minority stake in a family business or restricted stock options, you don’t have the luxury of picking up your phone and selling at market price within minutes.

The reduced ability to liquidate your investment introduces real financial risk and uncertainty. This is why valuations must reflect this reality.

Marketability vs. Liquidity

It’s important to distinguish between marketability vs. liquidity:

• Marketability refers to whether a market exists for something at all.
• Liquidity describes how quickly you can complete a transaction.

A piece of art may have a market of willing buyers, but taking months to sell it still introduces uncertainty and carrying costs. Similarly, shares in a closely held corporation may have no established market whatsoever. You must find a buyer willing to negotiate terms, which may prove difficult or impossible. DLOM accounts for these real-world challenges.

The discount reflects several practical costs:

• Time required to locate buyers
• Expense of conducting a valuation or audit
• Legal and accounting fees

You must prepare for the fact that you may never find a buyer at all.

Additionally, if you must sell quickly, you’ll likely need to accept a lower price. A private business owner may need to accept 20% to 40% less than the theoretical fair value to convert their stake to cash in a reasonable timeframe.

This isn’t pessimism; it’s a rational acknowledgment of how markets actually work.

How the Discount for Lack of Marketability Applies

One of the most common applications of DLOM is determining the fair market value of ownership stakes in private companies.

There are many reasons why a family business or privately held corporation may need a valuation. It may be selling a portion to an investor, bringing in a new partner or preparing financial statements.

Whatever the reason, accountants and valuation experts apply a DLOM to arrive at a realistic figure. Without this adjustment, the valuation would suggest that a small stake in a private company is worth roughly the same as an equivalent percentage of a comparable public company. This simply doesn’t reflect reality.

Estate Planning

DLOM plays a significant role in estate planning because the IRS requires accurate valuations of all assets you leave behind. ¹

If you pass away holding a meaningful stake in a private business or partnership, the estate’s executors and tax professionals will likely apply a DLOM when determining the estate’s total value for tax purposes.

This can meaningfully reduce the estate taxes your heirs owe, potentially preserving more wealth for the next generation.

Divorce

When divorcing spouses split assets, it may include stakes in private businesses or restricted company shares. In this case, courts and valuators rely on DLOM to ensure fair treatment.

Overvaluing an illiquid asset could unfairly advantage one spouse, while undervaluing it could harm the other. Applying an appropriate discount ensures that settlement negotiations recognize the asset’s true economic value.

Charitable Gifts

Say you plan to gift ownership in a private company to family members or donate shares to charity. The IRS will require you to determine the fair market value for tax reporting purposes.

DLOM helps establish this value defensibly. It can potentially reduce your taxable gift or allow for a larger charitable deduction. Donors who ignore marketability discounts risk overstating their contributions and facing IRS scrutiny.

Methods Used to Calculate the Discount for Lack of Marketability

Valuation professionals don’t simply guess at DLOM percentages. They rely on established methodologies that have been tested, refined and accepted by courts and tax authorities over decades.

These approaches range from analyzing historical data on restricted securities to applying mathematical models. Each offers different insights depending on the particular asset being valued.

Understanding which methods are most appropriate for your situation can help you work more effectively with financial advisors and valuators:

• Restricted stock studies. Researchers analyze the price difference between restricted shares, which you cannot sell immediately, and freely tradable shares of the same company. Discounts typically range from 20% to 40% ² .
• Pre-IPO transaction analysis. This method examines the prices investors paid for private company shares before the company went public. It then compares them to the IPO price to quantify the marketability discount.
• Option pricing models. Valuators use the Black-Scholes option pricing model ³ . This treats illiquidity as a constraint on the ability to realize value and derives a discount percentage based on estimated holding periods and volatility.
• Quantitative Marketability Discount Model. Known as the Finnerty Model, this sophisticated approach calculates a statistically derived discount ⁴ . To do so, it uses factors such as the length of the holding period, the volatility of comparable public companies and risk-free interest rates.
• Guideline company transactions. Professionals examine actual sales of similar private companies or stakes to determine what real buyers have paid relative to theoretical valuations, establishing market-based discount precedents.

Different valuation situations may warrant different methodologies; what works for a tech startup might not apply to a family manufacturing business.

Factors That Impact the Discount for Lack of Marketability Calculation

Not all illiquid assets are created equal, and the type of asset significantly influences the DLOM applied.

A minority stake in a stable, profitable family business with a clear succession plan warrants a different discount from that of shares in an early-stage startup with uncertain prospects. Real estate holdings, partnership interests and restricted securities each carry their own marketability challenges and recovery timelines. Valuation professionals carefully consider what makes an asset unique before settling on an appropriate discount percentage.

The stronger a company’s financial performance and balance sheet, the lower the DLOM tends to be. A buyer is more willing to acquire stakes in a profitable, cash-flowing business than in a struggling venture, reducing the urgency to accept a steep discount.

Conversely, a company with declining revenues, significant debt or uncertain prospects may warrant a higher discount because potential buyers demand greater compensation for the combined risk and illiquidity. This demonstrates how marketability improves when an asset is fundamentally sound.

Whether you own 2% or 51% of a company dramatically affects how easily you can sell that stake. Minority interests are inherently harder to market because buyers have less control over the company’s direction.

Meanwhile, controlling interests and larger blocks attract more potential purchasers. Valuation experts adjust DLOM accordingly. They recognize that the larger your stake relative to the company’s size, the easier it generally becomes to find interested buyers or negotiate a sale.

Bottom Line

A discount for lack of marketability recognizes that illiquid assets are generally worth less than comparable assets that can be sold quickly in an active market. Whether applied to a private business interest, restricted stock or a partnership stake, a DLOM helps produce a more realistic valuation by accounting for the challenges of finding a buyer and converting the asset into cash. Because marketability discounts can significantly affect business valuations, estate taxes, divorce settlements and charitable gifts, it’s important to work with qualified valuation and financial professionals when determining an appropriate discount.

Tips for Managing Your Investments

• Everyone’s financial goals and needs are very different, which is why the right amount of assets to keep liquid is going to vary widely by individual. A financial advisor can help you figure out the right amount and place for your liquid assets. Don’t have an advisor yet? Well, finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Once you’ve got a strong emergency fund, work on investing for your future and retirement. Set up an employer-sponsored 401(k) and take advantage of your job’s company match if there is one. You should also be actively contributing to an IRA, as well as investing in some riskier securities if you’re younger.

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