Discounts For Lack Of Marketability
Discounts for lack of marketability (DLOM) refer to the method used to help calculate the value of closely held and restricted shares. The theory behind DLOM is that a valuation discount exists between a stock that is publicly traded and thus has a market, and the market for privately held stock, which often has little if any marketplace.
Various methods have been used to quantify the discount that can be applied including the restricted stock method, IPO method, and the option pricing method.
Discount for Lack of Marketability (DLOM)
The Discount for Lack of Marketability (DLOM) is a method used to help calculate the value of non-public and restricted shares. The theory behind DLOM is that there is a valuation discount between publicly traded stocks and non-public stocks because publicly traded stocks have a market, while non-public stocks often have a very small market or none at all.
Origin
The concept of DLOM originated from valuation studies of non-public and restricted stocks. As early as the mid-20th century, financial scholars and appraisers began to notice that non-public stocks, due to their lack of marketability, were typically valued lower than publicly traded stocks. Over time, DLOM has become an important tool in business valuation and financial reporting.
Categories and Characteristics
The main methods for calculating DLOM include:
- Restricted Stock Method: Estimates the discount by comparing the price differences between restricted stocks and publicly traded stocks.
- Initial Public Offering (IPO) Method: Estimates the discount by analyzing stock price changes before and after a company's IPO.
- Option Pricing Method: Uses option pricing models to estimate the marketability discount for non-public stocks.
Each method has its pros and cons. The restricted stock method is straightforward but data may be hard to obtain; the IPO method relies on market data but may not be applicable to all companies; the option pricing method has a solid theoretical foundation but is complex to calculate.
Specific Cases
Case 1: A tech startup plans to raise equity financing, but its shares are not publicly traded. The appraiser uses the restricted stock method and finds that similar companies' restricted stocks are 20% lower than publicly traded stocks. Therefore, the appraiser applies a 20% DLOM to the company's shares.
Case 2: A family-owned business is preparing for an internal equity transfer. Since the business is not publicly listed, the appraiser uses the IPO method, analyzing similar companies' stock price changes before and after their IPOs, and determines a 15% DLOM.
Common Questions
Q1: Is there a standard method for calculating DLOM?
A1: There is no standard method; the calculation methods and results for DLOM may vary depending on the appraiser's choice and market conditions.
Q2: Is DLOM applicable to all non-public stocks?
A2: DLOM mainly applies to non-public stocks with poor marketability. For non-public stocks with better marketability, the DLOM may be lower or even not applicable.
