What can you do to reduce or eliminate the marketability discount?
Understanding the Discount for Lack of Marketability (DLOM) helps you plan and make informed decisions about the value of your business.
A client asked, “what can I do to reduce or eliminate the marketability discount?” The quick answer is “nothing,” but I realized in that moment that many business owners have this same question, but most don’t ask. Planning ahead can influence the size of the discount.
Definition of the Discount for Lack of Marketability (DLOM)
The Discount for Lack of Marketability (DLOM) is often the largest discount applied in valuing a privately held company. It reflects the degree to which an ownership interest can be converted to cash quickly, without unreasonable expense, and with certainty as to proceeds.
Why the Discount for Lack of Marketability Matters
As a small business owner planning to sell, your business value will almost always include a discount for lack of marketability (DLOM), and you have limited control over its size. Private businesses are inherently less marketable than publicly traded companies. Finding a buyer can take significant time, effort, and expense, while publicly traded shares can be sold quickly at transparent, market-driven prices. Even full ownership of a small business is less liquid than public stock. Market conditions vary widely, transactions are less predictable, and ownership transfers are often restricted. In addition, investors prefer liquidity, and lenders typically will not accept small business ownership as collateral.
What Determines the Discount for Lack of Marketability
DLOM reflects the difficulty of converting a business interest into cash and is primarily driven by the time value of money, business risk, and variability of cash flows.
In a valuation, the appraiser determines not whether DLOM applies, but how large the discount should be. Common methods—such as the restricted stock and IPO approaches—compare the value of privately held shares to their value once publicly traded. Studies over several decades generally indicate discounts ranging from 30% to 50%, with the final discount adjusted based on the specific characteristics of the business.
How to Reduce the Discount for Lack of Marketability
While much of the discount is driven by market conditions and valuation methods, business owners can influence several key factors: strong financial performance; consistent cash distributions; professional management (ability to operate without the owner); and fewer restrictions on ownership transfer.
Improving these areas can make the business more attractive to buyers and reduce the overall discount applied.
As a small business owner, your business value will include the application discount for lack of marketability regardless of all other factors. Finding a buyer who is interested in accepting this level of uncertainty presents the greatest challenge when selling a business and is a primary driver of the marketability discount. But you can influence the discount level with some strategic planning.