What is a Discount for Lack of Marketability?

The Discount for Lack of Marketability, often called a liquidity discount, is a fixed amount or percentage deducted from the selling price of a block of shares that lacks marketability. These are the closely held or restricted shares that cannot be resold in the market easily.

How Does a Discount for Lack of Marketability Work?

The publicly traded stocks have a ready market and can be converted into cash easily with minimum administrative costs and a high degree of certainty as to the net amount. On the other hand, the privately held stocks lack the marketplace. Depending on its nature, the discount rate is calculated by various methods including IPO method, restricted stock method, and the option pricing method. The IPO method calculates the price difference between the shares issued before the initial public offering and after it. The percent difference between the two is considered to be the discount for lack of marketability. The restricted stock method assumes the only difference between restricted stock and common stock is that the restricted stocks are not marketable. This difference leads to the price variance of these two types of share. In option pricing method, the option price as a percentage of the strike price is the DLOM. Studies have shown the discount for lack of marketability ranges between 30% and 50%. It is often difficult for the valuation analysts to evaluate the DLOM during disputes in generation-skipping transfer tax, estate tax, gift tax, income tax, property tax, and others. In the U.S. the Internal Revenue Service (IRS) provides some guideline for dealing with these issues.