ICYMI – Article originally appeared in 2015…. updated and revised for 2018! While getting my daily dose of Quora this morning, someone posed the question “What are the Top 5 Questions a VC should […]
Discounts for Control and Marketability
Value is in the eye of the beholder, right?
And when looking at certain assets – especially minority ownership in privately held companies – those assets are worth less than a simple fraction of the whole. Why? Read on.
Understanding DLOM and DLOC
When performing valuations, part of our analysis includes whether and to what extent the portion of the entity being valued should be subject to discounts. The two most common are the Discount for Lack of Control (“DLOC”) and the Discount for Lack of Marketability (“DLOM”).
Discount for Lack of Marketability
In the landmark case Mandelbaum (Bernard Mandelbaum, et al. v. Commissioner, T.C. Memo 1995-255), Judge Laro sets out ten factors that should be considered in applying a DLOM:
- The value of a similar corporation’s public and private stock
- An analysis of the Company’s financial statements
- The Company’s dividend-paying capacity and payment history
- The nature of the corporation, history, industry position, and economic outlook
- Degree of control transferred
- Restrictions on transferability
- Investor’s holding period
- The Company’s redemption policy
- Costs associated with a public offering of the stock
- These items are often the basis for applying a DLOM.
Discount for Lack of Control
A controlling ownership interest is typically more valuable than a pro-rata share of a minority interest. This is because the minority owner does not have control over important business decisions like declaring dividends, determining compensation, setting policies and deciding to sell or liquidate. To account for this disadvantage, an appraiser can apply a discount for lack of control to a minority interest. Factors that may indicate control, or a lack thereof, include:
- elect directors and appoint management
- determine management compensation and perquisites
- set policy and change the course of business
- acquire or liquidate assets
- select people with whom to do business and award contracts
- make acquisitions
- liquidate, dissolve, sell out, or recapitalize the company
- sell or acquire treasury shares
- register the company’s stock for a public offering
- declare and pay dividends
- change the articles of incorporation and bylaws
Below is an example calculating, on a minority, non-marketable basis, a 30% interest. Given a company with an EV of $10million, the 30% pro rata share, after the appropriate discounts, is valued at $1.6million.
$10,000,000 100% Enterprise Value (1,000 shares)
$3,000,000 30% Pro-rata Value (before discounts)
($690,000) Less: DLOC (23%)
$2,310,000 Minority, Marketable Value
($680,300) Less: DLOM (30%)
$1,619,700 Minority, Non-Marketable Value
Discounts apply when valuation is diminished based on control or marketability factors
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