One of the most significant and frequently debated adjustments in business valuation is the discount for lack of marketability (DLOM). This discount reflects the reduced value of an ownership interest in a private company compared to an otherwise identical interest in a publicly traded company. Because private company shares cannot be readily sold on an open market, buyers typically demand a lower price to compensate for the additional time, cost, and uncertainty involved in finding a buyer and completing a transaction.

Why Marketability Matters

Publicly traded stocks can be sold within seconds on a stock exchange with minimal transaction costs. Private company interests, by contrast, may take months or years to sell, often involve significant legal and transaction costs, and may be subject to transfer restrictions in operating agreements or shareholder agreements. This lack of liquidity represents a real economic cost to the holder, and the DLOM attempts to quantify that cost. The magnitude of the discount depends on factors specific to the company, the interest being valued, and the applicable restrictions on transfer.

Empirical Studies Supporting DLOM

Several categories of empirical studies provide evidence for the magnitude of marketability discounts. Restricted stock studies examine the price difference between publicly traded shares and restricted (unregistered) shares of the same company, typically finding discounts ranging from 20% to 35%. Pre-IPO studies compare the prices of private transactions in company stock before the company goes public with the subsequent IPO price, often finding larger discounts in the 30% to 50% range. While these studies provide useful benchmarks, they have limitations, and experienced appraisers consider them as starting points rather than definitive answers.

The Mandelbaum Factors

In the landmark Tax Court case Mandelbaum v. Commissioner, the court identified factors relevant to determining an appropriate DLOM. These include the financial statement analysis, dividend policy, nature of the company, management structure, amount of control in the transferred shares, restrictions on transferability, holding period expectations, the company’s redemption policy, and costs associated with making a public offering. Most experienced appraisers use the Mandelbaum factors as a framework for analyzing the specific circumstances of each engagement and supporting their selected discount.

DLOM in Gift and Estate Tax Valuations

The DLOM is particularly important in gift and estate tax valuations, where the IRS frequently challenges the magnitude of claimed discounts. A well-supported DLOM can significantly reduce the taxable value of gifted or bequeathed business interests, but the discount must be thoroughly documented and defensible. The IRS has its own valuation experts who review these discounts, and claims that are not adequately supported are likely to be challenged on audit. Working with experienced, credentialed appraisers who understand IRS expectations is essential for gift and estate tax engagements.

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