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What is DLOM?

DLOM arises from the inherent difference in marketability between publicly traded and privately held companies. Publicly traded companies have shares that are highly liquid and can be quickly sold on stock exchanges. In contrast, private companies do not have a centralized market for their shares, making them harder to buy and sell. This lack of marketability reduces the value of these shares because potential buyers are willing to pay less for assets that are difficult to liquidate.

For instance, if you own shares in a private company, you might find it challenging to sell them quickly or at a fair price compared to selling shares of a publicly traded company. This disparity in marketability is what DLOM aims to quantify and adjust for in business valuations.

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Methods for Calculating DLOM

Restricted Stock Method

The Restricted Stock Method is one of the most common approaches to calculating DLOM. This method involves comparing the prices of restricted and unrestricted shares of publicly traded companies. Restricted shares are those that cannot be sold immediately due to regulatory or contractual restrictions, similar to the situation with private company shares. By analyzing the price difference between these restricted and unrestricted shares, valuators can estimate the DLOM. For example, if restricted shares trade at a 20% discount to unrestricted shares, this discount could be applied as a proxy for DLOM.

IPO Method

The IPO Method calculates DLOM by analyzing the price difference between pre-IPO (Initial Public Offering) and post-IPO shares. Before going public, a company’s shares are less marketable because they are not listed on any exchange. After the IPO, these shares become highly liquid and tradeable. The increase in value post-IPO reflects the improved marketability, and this difference can be used to estimate DLOM.

Option Pricing Method

The Option Pricing Method uses the prices of options and their strike prices to estimate DLOM. This method leverages the independent market for options to inform the value of DLOM. By analyzing how options are priced relative to their underlying assets, valuators can derive a discount that reflects the lack of marketability in private company shares.

Factors Influencing DLOM

Several factors influence the magnitude of DLOM:

• Costs associated with making a public offering: The costs and complexities involved in taking a company public can impact how much of a discount is applied.

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  Company redemption policy and holding period for stock: Companies with policies that allow for easier redemption or shorter holding periods may have lower DLOMs.

• Restrictions on transferability of shares: Shares with significant restrictions on transferability will generally have higher DLOMs.

• Amount of control in transferred shares: The level of control associated with the shares being transferred can also affect DLOM.

• Company management and economic outlook: A company’s management quality and economic outlook can influence investor confidence and thus impact DLOM.

• Dividend policy: Companies with generous dividend policies might attract more investors, reducing DLOM.

• Financial statement analysis: The overall financial health and performance of the company as reflected in its financial statements also play a role.

These factors highlight that DLOM is not a one-size-fits-all adjustment but rather a nuanced consideration that depends on various company-specific elements.

Quantifying DLOM

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Valuators typically quantify DLOM using empirical evidence from restricted stock studies and pre-IPO studies. These studies suggest that median DLOMs often range between 30% to 50%, though this can vary significantly based on the specific circumstances of each company. For example, a private company with highly restrictive transfer policies might have a higher DLOM compared to one with more lenient policies.

Challenges in Applying DLOM

Applying DLOM is not without its challenges. One major issue is the complexity of valuing noncontrolling, nonmarketable ownership interests. There is also an overlap with other discounts such as Discount for Lack of Liquidity (DLOL) and Discount for Lack of Control (DLOC), which can make it difficult to isolate the exact impact of DLOM.

Additionally, the subjective nature of some factors influencing DLOM means that different valuators might arrive at different estimates for the same company, adding to the complexity.

Accounting Standards and DLOM

Accounting standards such as IFRS 2 (Share-based Payment) and IFRS 13 (Fair Value Measurement) provide guidance on how to apply DLOM in certain contexts. These standards are particularly relevant when valuing share-based payments and financial instruments where marketability is a key consideration.

For instance, IFRS 13 requires that fair value measurements consider the highest and best use of an asset, which includes considerations around marketability. Adhering to these standards ensures consistency and transparency in the valuation process.

Practical Application of DLOM

To illustrate how DLOM is applied in practice, let’s consider an example using the Restricted Stock Method:

Suppose a private company’s valuation is $10 million without considering DLOM. If studies show that restricted shares of similar publicly traded companies trade at a 25% discount to their unrestricted counterparts, this could be used as an estimate for DLOM. Applying this discount would reduce the valuation to $7.5 million ($10 million * (1 – 0.25)).

This example demonstrates how DLOM can significantly impact the valuation of a private company’s shares by reflecting their reduced marketability.

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