Discounts for Lack of Control and Marketability
A 10% interest in a private company is not always worth 10% of the value of the entire company. Its owner may have little power over distributions or major decisions, and there may be no ready market in which to sell it. Valuation professionals analyze these limitations through the discount for lack of control (DLOC) and the discount for lack of marketability (DLOM).
Brookline Valuation Services, Inc. analyzes control and marketability in valuations of closely held businesses, LLCs, partnerships, and other private ownership interests. These issues frequently arise in gift and estate tax appraisals, ownership transfers, and disputes. Our objective is to determine whether an adjustment is warranted and, if so, support its magnitude with evidence relevant to the particular interest.
Discount for Lack of Control
A DLOC reflects the economic effect of an owner’s inability to direct decisions that influence value. The percentage owned matters, but the rights granted by governing documents and the practical operation of the entity matter as well.
Variables we consider include:
- Manager selection: The ability to elect or remove managers or directors.
- Voting thresholds: Voting thresholds for major decisions and whether the interest has blocking or swing-vote power.
- Operating decisions: Authority over distributions, compensation, budgets, and financing.
- Major transactions: The ability to sell assets, merge, dissolve, or liquidate the entity.
- Governing agreements: Rights under operating agreements, partnership agreements, and buy-sell agreements.
- Other owners: The number and concentration of other owners.
- Starting level of value: Whether the valuation method already reflects a noncontrolling interest.
Discount for Lack of Marketability
A DLOM reflects the relative difficulty of converting an ownership interest into cash at its indicated value. A private interest may take time and expense to sell, and the eventual proceeds may be uncertain. Its marketability depends on more than the fact that the entity is privately held.
Variables we consider include:
- Transfer limits: Restrictions on transfers and requirements for approval by other owners.
- Liquidity rights: Redemption rights, put rights, or other opportunities to obtain cash.
- Holding period: Expected holding period and prospects for a sale or other liquidity event.
- Distributions: Historical and expected distributions.
- Financial risk: The entity’s financial condition, earnings, and risk.
- Buyer pool: The size of the interest and the likely pool of qualified buyers.
- Information access: Access to reliable financial information.
- Sale process: The costs, time, and uncertainty involved in selling the interest.
- Existing inputs: Whether limited marketability is already reflected in the cash flows, discount rate, or other valuation inputs.
How We Apply the Analysis
Discounts are not standard percentages added to every appraisal. We identify the starting level of value, evaluate control and marketability separately, and avoid counting the same limitation twice. Depending on the governing standard of value, valuation method, and facts, one discount, both discounts, or neither may be appropriate.
Our reports explain the rights and restrictions of the interest, the evidence considered, and the reasoning behind the resulting value conclusion. This is particularly important when a valuation will support a Form 709 gift tax filing or a Form 706 estate tax filing. Read more about our valuation of LLC and partnership interests.
Have a minority or otherwise restricted ownership interest to value? Contact Brookline Valuation Services to discuss the interest, the valuation date, and the documentation available.