Understanding Discount for Lack of Marketability ("DLOM")

When it comes to valuing private companies, two essential adjustments often come into play: the Discount for Lack of Marketability ("DLOM") and the Discount for Lack of Control ("DLOC"). These concepts help ensure valuations reflect the real-world limitations investors face, especially when securities aren’t publicly traded or when investors don’t have decision-making authority.

For the first of the two adjustments, DLOM, let’s break down the adjustment, when it apply, and how to quantify it. For DLOC, please see our other article.

What is Marketability (and Why Does it Matter)?

Marketability refers to how easily and quickly a security can be sold at a fair price. In most valuation contexts, marketability and liquidity are treated as the same thing, even if some guidelines (like IPEV) draw subtle distinctions.

Publicly traded securities are inherently marketable. But when dealing with private companies, marketability is limited, and thus we apply a DLOM to adjust for that lack.

Is My Security Marketable?

Here’s a quick rule of thumb:

• Marketable: Public securities or private securities with high trading activity (e.g., near an IPO or many recent secondary sales).

• Non-Marketable: Most private positions, where selling is slower and less certain.

The valuation approach must match the nature of the security. If you’re valuing a non-marketable security using a marketable method (e.g., public comparables), a DLOM is necessary to adjust the result.

Key Valuation Methods and Their Marketability

Valuation Method	Marketability
Public Trading Comparables	Marketable
Private M&A Transactions	Non-Marketable
Public M&A Transactions	Marketable
DCF using Market WACC	Marketable*
VC-Style Discount Rates	Non-Marketable

*Unless WACC includes a calibrated alpha, in which case it may be considered non-marketable.

Applying the DLOM

When adjusting a marketable value to reflect non-marketability, we apply a Discount for Lack of Marketability. Conversely, if you're going the other way, a Marketability Premium may be applied (though rarely used in practice).

Common DLOM Models

1. Restricted Stock Studies: Show discounts ranging from 13%–45%. These are based on securities that can’t be traded for a period.

2. Pre-IPO Studies: Compare prices before and after IPOs, showing implied discounts of 21%–66%. However, these are biased toward successful IPOs.

3. Chaffe Protective Put Model: Uses option pricing to estimate what investors would pay to "insure" marketability. Yields 13%–45% discounts.

4. Longstaff Lookback Option: Estimates opportunity cost from not selling at the peak. Produces 17%–31% discounts.

5. Finnerty Asian Put Model (Preferred Model): Combines empirical research with option theory, yielding more realistic and consistent results. Typical discounts range from 10%–15%, though higher discounts (30%–35%) can apply under long restriction periods and high volatility.

   
   

   DLOM models 1 through 5 have many inherent biases and overstate the DLOM by almost double. The preferred choice of DLOM model is the Finnerty model.

   
   

Where Do You Apply the DLOM?

Apply it to equity value excluding cash, because:

• Cash is fully liquid—no discount needed.

• Debt is contractual and not affected by marketability.

  
  

Final Thoughts

• Align your valuation method with the characteristics of the security (marketable vs non-marketable).

• Use DLOM adjustments only when appropriate, and only to the equity portion of the business.

• Calibrated valuations typically do not require DLOM/DLOC adjustments, as market conditions are already priced in.