The Discount for Lack of Marketability (DLOM) accounts for the often unknown (from an outsiders perspective) difficulty in converting a privately held business to cash, especially when compared to publicly traded stocks.
Defining Discount for Lack of Marketability
DLOM — short for Discount for Lack of Marketability — represents the “after the business has turned into cash” value, of privately held businesses. This is a million miles away from publicly listed companies, which can typically be sold almost instantly. It is one of the three standard discounts used in business valuation.
Private company sales, on the other hand, tend to involve lengthy processes with high up front fees (depending on the size of the business), high commissions, long time frames, and despite all of that, even desireable privately held businesses struggle to sell, while less desirable businesses ends up the in the somewhat dark statistics.
And this is despite the fact that the US government, thru SBA 7(a) guarantees business acquistion financing, although with a very long and complicated term sheet, and how US business buyers and sellers are somewhat used to seller financing, in the event the business or the buyer, does not qualify for SBA financing. In places like Europe, there is no SBA and seller financing is generally not accepted by sellers, meaning that the need for DLOM is even greater, although ironically, less frequently applied there.
Proper Use of the DLOM
Although the idea behind DLOM is well established, applying it appropriately — just like with the Discount for Lack of Control (DLOC) or Key Person Discount — requires careful, situation-specific judgment.
Collections of studies — many of which are based on datasets and market environments dating back decades, some as far as the Vietnam era — often fall short of providing the nuanced insight needed for current valuation. Blindly applying these old benchmarks, without considering the specific facts of the case, conflicts with both Revenue Ruling 59-60 and today’s economic landscape.
It cannot be stated enough how the data is heavily skewed. Smaller businesses, even the most desirable ones, will always struggle to sell, while larger businesses, will generally always sell, even the less desirable ones, as long as the valuation is based on actual earnings, and not claimed potential or ambitious projections made by management. Moral of the story, this is a small size business issue, only.
When is a DLOM Necessary?
There is never a strict requirement to apply a Discount for Lack of Marketability (DLOM), but the issue of marketability must be addressed. Failing to do so suggests a lack of familiarity with the realities of the small and midsize business (SMB) transaction market.
At the same time, it is equally problematic to indiscriminately insert a generic compilation of studies into every valuation report, as if meaningful analysis has been performed. A valuator who does this likely lacks real-world transaction experience—and could benefit greatly from gaining it.
It is entirely acceptable to address marketability directly and to specify whether the capitalization rate used is considered marketable. There is no need to complicate the process by first selecting a non-marketable capitalization rate and then applying a DLOM as an afterthought.
Many business valuators do this, only as an excercise to prove that their capitalization is marketable, which is another example of trying hard to make it look like footwork has been done, when in fact, no footwork was done, because it just just copy and paste.
Our valuations are intentionally structured to comply with both the intent and technical requirements of Revenue Ruling 59-60, which explicitly discourages the use of mechanical, formulaic methods.
