• Home
  • About Terryl
  • Email Signup
  • Services
    • Business Valuation
    • Strategic Plan Development and Implementation
    • Business Plan Development
    • Exit Strategy Development and Planning
    • Fractional CFO Services
    • Budgeting and Forecasting
    • Business Owner Coaching & Education
  • Articles
  • Contact

Header Right

  • Email
  • LinkedIn
  • Menu
  • Skip to right header navigation
  • Skip to main content
  • Skip to footer

Terryl Peterson CFO

Terryl Peterson CFO Services

Header Right

  • Email
  • LinkedIn
  • Home
  • About Terryl
  • Email Signup
  • Services
    • Business Valuation
    • Strategic Plan Development and Implementation
    • Business Plan Development
    • Exit Strategy Development and Planning
    • Fractional CFO Services
    • Budgeting and Forecasting
    • Business Owner Coaching & Education
  • Articles
  • Contact

Marketability Discount in a Business Valuation

During a recent meeting to finalize a valuation engagement, my client asked me what could be done to reduce or eliminate the marketability discount. The quick answer is “nothing.” Then I had to explain why. After this experience, I realized that many business owners have this question, but most don’t ask.

The Discount for Lack of Marketability (DLOM) is probably the largest discount applied in determining the value of a privately held company and is appropriate in determining the Fair Market Value of a privately held company. The reason for such a discount to be considered is the lack of a ready market for the ownership of such a company. Marketability is the degree to which an ownership interest can be converted to cash quickly, without unreasonable expense, and with certainty as to the amount of sale proceeds.

The difficulty in identification of a buyer for a privately-owned business is a significant factor influencing the need for a DLOM. Even a 100% ownership in a small business is less marketable than the stock of a public company. Selling a small business requires considerable effort, time, and expense on the part of the business owner. In addition, the market for small businesses may vary significantly, which affects the actual selling price and terms.

A fully marketable business ownership interest is a publicly traded stock. You can call your broker to sell your shares, the price is determined based on the activity of the market and is publicly available. The transaction can be completed the same day, and the cash is available to you within three days.

A nonmarketable business is a privately held company that pays no dividends to owners and has restrictions on transfers of ownership.

There are three primary factors driving the marketability discount; time value of money, business risk, and variability of cash flow. Investors generally prefer liquidity – the ability to sell a business interest quickly – so steer clear of privately held companies. The situation is further impacted by the fact that most banks will not accept the ownership of a small business as collateral for a loan.

As part of the business valuation process, the appraiser has to determine not if a DLOM is appropriate, but how much of a discount is appropriate. There are several methods used to select an appropriate discount, including the restricted stock method and the IPO method. Both of these approaches compare stock prices for the same company with differing circumstances – when the stock is not publicly traded compared to when it is publicly traded. The DLOM is determined from the difference in these prices. There have been a large number of studies conducted, spanning decades, to assess the discount rate that would be applied to fully marketable value. The results of the studies vary, but the consensus is that the discounts range from 30% to 50%. These discounts have remained consistent throughout changes in the economy and overall market.

The analyst completing the valuation must look beyond the results of the studies to further assess the individual business on a number of factors. These factors influence the final discount that is applied.

The most significant part of the DLOM is determined through the application of an appropriate industry methodology, but a business owner does have some limited impact on the final DLOM, including:

  • Financial performance
  • Cash distribution policy
  • Professional management (can the business run without the owner?)
  • Restrictions on ownership transfer

These factors can decrease or increase the final DLOM and are typically considered after the analyst selects the more generalized DLOM based on studies and other factors that the business owner is not able to influence.

Finding a buyer who is interested in accepting this level of uncertainty presents the greatest challenge when selling a business and is the driving force behind the marketability discount. As a small business owner, your business value will include the application of a marketability discount regardless of all other factors that are considered in determining the value. You have limited ability to influence the discount level, so focus on building value in your business by making it a profitable business that will attract a buyer when you are ready.

Previous Post: « Budget Development and Management
Next Post: Buyer Beware »

Footer

Contact Information

Terryl Peterson
(970)-759-3876
terryl@terrylpetersoncfo.com

Highlights

  • Business Valuation
  • Strategic Planning
  • Cash Flow Planning
  • Planning & Forecasting
  • Fractional CFO
  • CFO Services
  • Profit Maximization
  • Email
  • LinkedIn
  • Phone

Copyright © 2021 · Mai Law Pro on Genesis Framework · WordPress · Log in