Key takeaways
- A minority interest in a private company is usually worth less than its pro rata share of the whole business, because the holder cannot control the company and cannot easily sell the interest.
- The discount for lack of control (DLOC) reflects the absence of control rights; the discount for lack of marketability (DLOM) reflects the difficulty and cost of converting the interest to cash.
- Discounts are applied sequentially, not added together, and must be supported by evidence specific to the interest and the company.
- Whether discounts apply at all depends on the standard of value and the purpose. They are routine in gift and estate tax valuations but often limited in shareholder disputes.
Ask a family business owner to value a 20% stake in a $10 million company and the instinctive answer is $2 million. In many contexts, a professional appraiser will conclude a materially lower figure. The reason is two of the most important, and most frequently challenged, concepts in private company valuation: the discounts for lack of control and lack of marketability.
Levels of value
Valuation professionals think of value in levels:
- Controlling, marketable – the value of the whole company to a buyer who can control it, as if it could be sold readily.
- Minority, marketable – the value of a non-controlling interest that could still be sold readily (as with publicly traded shares).
- Minority, non-marketable – the value of a non-controlling interest in a private company with no ready market.
DLOC moves value from level 1 to level 2. DLOM moves it from level 2 to level 3. Which level an analysis starts from depends on the method used. For example, a guideline public company method may produce a minority, marketable indication, while a guideline transaction method often produces a controlling indication.
Discount for lack of control (DLOC)
A controlling owner can set compensation and distributions, choose management, decide strategy, sell or recapitalize the company and change the governing documents. A minority owner usually can do none of these.
How DLOC is measured:
- Control premium studies. Analysts look at premiums paid in acquisitions of public companies over their pre-announcement trading prices, and convert a premium into an implied discount: DLOC = 1 − 1 ÷ (1 + control premium). A 30% control premium implies a DLOC of about 23%.
- Comparison of returns. Studies of returns to minority investments, such as closed-end funds or limited partnership interests trading at discounts to net asset value, are often used for holding entities.
- Company-specific factors. Governing documents, voting rights, the distribution history, the presence of other blocks of stock (swing value), state law protections and whether the controlling owner extracts benefits.
Important nuance: if the cash flows used in the valuation already reflect a minority perspective (no control adjustments to owner compensation, for instance), a separate DLOC may be inappropriate or should be smaller. Our article on normalization adjustments and add-backs explains how control and minority adjustments differ.
Discount for lack of marketability (DLOM)
Even a controlling interest in a private company takes time and money to sell. A minority interest in a private company may have no market at all except, perhaps, the other owners.
How DLOM is measured:
- Restricted stock studies. Compare prices of restricted shares of public companies (which could not be sold for a period) with their freely traded equivalents.
- Pre-IPO studies. Compare private transaction prices before an initial public offering with the later IPO price.
- Option-pricing models. Estimate the cost of a put option that would guarantee the ability to sell at today’s value over the expected holding period (for example, the Chaffe, Longstaff and Finnerty models).
- Quantitative or cash-flow models. Estimate the return a buyer would require to hold an illiquid interest over an expected holding period, given expected distributions and growth.
Factors courts and the IRS consider
In Mandelbaum v. Commissioner (1995), the U.S. Tax Court listed factors relevant to the size of a marketability discount, which are still widely cited:
- Financial statement analysis and the company’s size and stability
- Dividend or distribution policy and history
- The nature of the company, its history, industry position and economic outlook
- Management quality
- The amount of control in the transferred shares
- Restrictions on transferability
- The expected holding period
- The company’s redemption policy
- Costs associated with a public offering
The IRS has also published a Discount for Lack of Marketability Job Aid for its appraisers, which emphasizes linking each discount to specific evidence about the subject interest rather than relying on averages.
How discounts are applied: a worked example
Assume a 100% controlling, marketable value of equity of $10,000,000 and a 20% non-voting interest.
| Step | Calculation | Value |
|---|---|---|
| Pro rata value of 20% | $10,000,000 × 20% | $2,000,000 |
| Less DLOC (illustrative 15%) | $2,000,000 × (1 − 0.15) | $1,700,000 |
| Less DLOM (illustrative 25%) | $1,700,000 × (1 − 0.25) | $1,275,000 |
| Fair market value of the interest | $1,275,000 |
The combined effect is about 36% (1 − 0.85 × 0.75), not 40%, because the discounts are applied sequentially. The percentages above are purely illustrative. Supportable discounts vary widely with the facts, and must be explained and evidenced.
When discounts apply, and when they don’t
| Context | Are discounts typically applied? |
|---|---|
| Gift and estate tax (fair market value) | Yes, where supported by the facts. See gift and estate tax business valuation. |
| Family limited partnerships and holding companies | Often, and heavily scrutinized |
| Buy-sell agreements | Depends on the agreement’s valuation clause. See buy-sell agreement valuation clauses. |
| Shareholder oppression and dissenting shareholder cases (fair value) | Frequently excluded or limited by state law and case law. See fair value in shareholder disputes. |
| Divorce | Varies by state and by court. See divorce business valuation. |
| Financial reporting (fair value under ASC 820) | Considered at the level of the unit of account, with specific rules |
| ESOPs | Considered in light of put rights and repurchase obligations |
The applicable standard of value drives this. Our article on standards of value: fair market value vs. fair value explains why the same interest can have different values for different purposes.
Common mistakes that invite challenge
- Using an average from a study without explaining why it fits the subject interest.
- Double-counting risk: applying a high discount rate for illiquidity and a full DLOM as well.
- Applying DLOC to a controlling interest, or to cash flows already on a minority basis.
- Ignoring the governing documents, such as transfer restrictions, put rights or mandatory distribution provisions that change marketability.
- Discounts that look reverse-engineered to reach a target value for tax purposes.
Planning and succession
Discounts are central to family business succession and estate planning, where minority interests are often transferred over time to the next generation. Getting the valuation right, and documented, is what makes those transfers defensible. Read family business succession: why valuation comes first. For heirs dealing with a business owner’s broader estate, DebtRemediationTools.org explains what happens to debt when someone dies, and offers a short primer on business valuation basics.
Frequently asked questions
There is no single typical figure. Empirical studies show a wide range, and appraisers must tie the discount to the specific interest’s facts, such as distributions, expected holding period and transfer restrictions.
No. They are applied one after the other, so a 15% DLOC followed by a 25% DLOM produces a combined discount of about 36%, not 40%.
Yes, when they are well supported. The IRS challenges discounts that rely on generic averages or ignore the facts of the interest. A thorough, credentialed appraisal is the best defense.
DLOC does not. A DLOM may still apply to a controlling interest in a private company in some circumstances, typically smaller than for a minority interest.
It depends on the agreement and the governing law. Many buy-sell agreements specify whether discounts apply; in court-ordered fair value cases, many states limit or exclude them.
Next step
Transferring ownership, resolving a dispute or planning an estate? Foxboro Consulting Group’s credentialed analysts prepare defensible valuations of minority and controlling interests. Contact us to discuss your situation.
This article is for general information and is not legal or tax advice. Discounts depend on specific facts, standards of value and jurisdiction.
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