What it means
Shares in a listed company can be sold within seconds at a visible price. Shares in a private company are different, because there may be no ready buyer, no public price and restrictions on who can purchase them.
That difficulty has a cost, and DLOM is the way valuers put a number on it. The discount is applied after estimating what the asset would be worth if it were freely traded.
A valuer begins with a marketable value, often derived from comparable listed companies or from a cash flow forecast. The DLOM is then subtracted to reflect the extra risk and delay of finding a buyer.
DLOM matters in many business settings. It appears in valuations for tax, divorce, shareholder disputes, employee share schemes and the sale of minority stakes in private firms.
A larger discount lowers the stated value, so it can change the tax payable or the price at which a stake is bought. Valuers estimate it using several approaches.
They may study the price gap between restricted shares and freely traded shares of the same company, look at the discount on private placements before a company lists, or use option pricing models that treat the inability to sell as a cost. The result depends on factors such as the size of the stake, how long it must be held and how profitable the company is.
The discount is often cited in a range of roughly 10% to 40%, but there is no fixed figure that applies to every case. Courts, tax authorities and advisers regularly debate it, so the reasoning behind the chosen percentage should be documented.
A separate adjustment, the discount for lack of control, applies where a holder cannot influence decisions, and the two should not be confused. Companies preparing for a sale or listing often ask how large the discount will be.
As a business grows, adds profits and creates a clearer route to a sale, the discount tends to shrink. Management teams who build audited accounts and a credible exit plan can therefore improve the value of their shares.
In practice
Real-world examples.
Example
A founder gifts part of her shares in a family company to her children. The tax authority accepts a valuation that includes a DLOM, because the shares cannot easily be sold on the open market. The lower value means the gift tax due is smaller, but the family keeps detailed records of how the discount was set.
Example
An employee leaves a technology start-up and the company buys back his shares. An independent valuer applies a DLOM to reflect that the shares have no public market, which lowers the buyback price. The leaver accepts the price because the shares could not be sold to anyone else.
Example
Two partners in a property firm disagree about the price for one partner's stake. They hire a valuer, who explains that a buyer would demand a discount because the stake is hard to sell, and the parties settle on a lower figure. The valuer's report is shared with both sides and used as the basis for a written agreement.
Formula
Calculation
Value after DLOM = marketable value x (1 - DLOM)
Discount in dollars = marketable value x DLOM
Worked example: A 10% stake in a private company would be worth $5,000,000 if it were freely tradable. A valuer concludes that a DLOM of 25% is appropriate.
Discount in dollars = $5,000,000 x 25% = $1,250,000.
Value after DLOM = $5,000,000 x (1 - 0.25) = $5,000,000 x 0.75 = $3,750,000.
Check: $5,000,000 - $1,250,000 = $3,750,000.
A smaller discount raises the result. At a DLOM of 15% the same stake would be worth $5,000,000 x 0.85 = $4,250,000, which is $500,000 more than at 25%.Case study
Seen in the real world.
Larkspur Engineering is a fictional private manufacturer owned by three families. When one family wanted to exit, the others had to agree a price for their 30% holding.
An independent valuer estimated the marketable value at $12,000,000 and proposed a DLOM of 20%. In this illustrative case, the selling family argued that the discount was too high because the company paid regular dividends and was likely to be sold or listed in a few years.
After discussion, the valuer reviewed the dividend history and the expected holding period and agreed to a discount of 15%. The price became $12,000,000 x 0.85 = $10,200,000. The illustrative lesson is that the supporting reasoning matters as much as the percentage. Both families signed the agreement and agreed to refresh the valuation every three years for any future sale.
Watch out
Common mistakes.
- Using a rule-of-thumb percentage without justification. Each case depends on facts such as dividend history, size of the stake and expected time to sale. It also helps to check what the company's own shareholder agreement says about transfers.
- Confusing DLOM with a discount for lack of control. One reflects difficulty of sale while the other reflects limited influence, and both may apply separately. They are separate adjustments, so a minority stake in a private company might attract both.
- Applying DLOM to listed shares that trade freely. The discount is for assets without a ready market. A free market already provides the ability to sell quickly, which is what the discount compensates for.
Questions
People also ask.
What is DLOM in simple terms?
It is the price reduction a buyer would expect because an asset is hard to sell quickly. It is commonly used for private company shares, restricted stock and other illiquid holdings.
Who decides the percentage?
Usually an independent valuer, whose reasoning may be challenged by tax authorities, courts or the other party. Tax authorities may challenge the number if the reasoning is weak or unsupported.
Does a higher DLOM mean a riskier company?
Not necessarily, as the discount reflects how hard the shares are to sell as well as the company's own risk. The size of the discount depends on the buyer's likely holding period, the dividend record and the prospects for a sale.
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