Empirical Studies on the Discount for Lack of Marketability (DLOM)

In business valuation, the Discount for Lack of Marketability (DLOM) is applied to reflect the diminished value of an ownership interest that cannot be readily converted to cash. Unlike publicly traded securities, which can be sold almost instantaneously on an exchange, privately held equity requires significant time, cost, and uncertainty to liquidate.

To quantify this discount, valuation professionals and the courts rely heavily on empirical data derived from two primary sources: restricted stock studies and pre-IPO studies. The aggregate of these studies consistently indicates average marketability discounts ranging between 35% and 50%[1]. Furthermore, when combined with a Discount for Lack of Control (DLOC), the total reduction from enterprise fair market value can be substantial, particularly in family-owned or closely held enterprises.

Restricted Stock Studies

Restricted stock studies analyze the price difference between freely traded public shares and identical shares of the same company that are subject to trading restrictions (typically under SEC Rule 144). Because the only difference between the two classes of stock is the ability to sell them immediately, the price differential isolates the pure cost of illiquidity.

Over the past five decades, numerous academic and institutional studies have analyzed these transactions. The foundational studies established the baseline for DLOM application in tax and litigation contexts:

• SEC Institutional Investor Study (1971): The earliest major study, analyzing 398 transactions between 1966 and 1969. It found an overall mean discount of 25.8%, but noted that for non-reporting OTC companies, the average discount was 32.6%[2].
• Gelman Study (1972): Analyzed 89 transactions by four closed-end investment companies between 1968 and 1970, finding both a mean and median discount of 33%[3].
• Moroney Study (1973): Robert E. Moroney analyzed 146 purchases by 10 registered investment companies, concluding an average discount of 35.6% and a median of 33.0%[4].
• Maher Study (1976): J. Michael Maher examined purchases by four mutual funds from 1969 to 1973, determining an average discount of 35.43%[5].
• Silber Study (1991): William L. Silber analyzed 69 restricted stock placements between 1981 and 1988, finding an average discount of 33.75%[6].

The aggregate average of these foundational restricted stock studies centers around 35%. It is important to note that these studies measure the discount for stock that will become freely tradable after a known holding period (historically two years). For a privately held company with no anticipated liquidity event, the actual marketability discount is theoretically higher.

Pre-IPO Studies

Pre-IPO studies approach the marketability discount from a different angle. They compare the price at which a company's stock was sold in private transactions prior to an Initial Public Offering (IPO) with the price at which the stock was subsequently offered to the public in the IPO.

The most prominent of these are the Emory Studies, conducted by John D. Emory Sr. across multiple time periods from 1980 through 2000. Emory analyzed hundreds of prospectus documents to find transactions occurring within five months prior to the IPO.

The Emory studies consistently demonstrated higher discounts than the restricted stock studies, reflecting the greater uncertainty of a private company compared to a public company issuing restricted shares. Across the various Emory studies covering 1980 to 2000, the mean discount was 46%, and the median was 47%[7].

Similarly, Willamette Management Associates conducted a series of pre-IPO studies covering the years 1975 through 1997. Their findings aligned closely with Emory, showing average discounts ranging from 31.8% to 73.1% depending on the specific year, with a long-term average hovering around 50%[8].

The aggregate of the pre-IPO studies indicates an average discount of approximately 50%, providing the upper bound of the standard 35% to 50% DLOM range cited in valuation literature.

The Compounding Effect: DLOM and DLOC

In the valuation of minority interests in privately held companies, the Discount for Lack of Marketability is rarely applied in isolation. It is frequently applied in conjunction with a Discount for Lack of Control (DLOC), which accounts for the minority shareholder's inability to direct corporate strategy, declare dividends, or force a sale.

These discounts are multiplicative, not additive. If a valuation concludes a 25% DLOC and a 40% DLOM, the combined discount is calculated sequentially: an asset worth $100 on a marketable, controlling basis is reduced by 25% to $75 (reflecting lack of control), and then reduced by a further 40% to $45 (reflecting lack of marketability). The total effective discount is 55%.

In specific scenarios, particularly involving family-owned companies or highly restrictive partnership agreements, the combination of these discounts can be extreme. Family limited partnerships (FLPs) and closely held family corporations often feature operating agreements designed specifically to restrict transferability and consolidate control. In these structures, a minority owner may have zero prospect of liquidity and zero influence over cash flows.

Valuation experts and legal scholars note that in such highly restrictive environments, the lack of control and marketability discounts can aggregate to reduce the fair market value of the minority interest by as much as ninety percent compared to its pro-rata share of the enterprise's net asset value[9]. While such extreme discounts face intense scrutiny from tax authorities, they reflect the economic reality that a minority interest in a family-controlled entity with strict transfer prohibitions possesses negligible present value to a hypothetical willing buyer.