Understanding the 10% Discount for Lack of Marketability (DLOM) in 409A Valuations: If you start your business in any industry, you know offering stock options to attract talent is a regular activity. But for accurate value through 409A valuations, companies need to figure out the worth of their common shares to issue options tax-free for employees.

Private company stocks are less liquid as compared to public company stocks. This lack of liquidity often creates complexities when shares are being valued in the company. Understanding the 10% Discount for Lack of Marketability (DLOM) in 409A Valuations is crucial for ensuring fair, compliant, and realistic valuations of private company shares. This discount acknowledges the reduced marketability of private shares, providing a more accurate picture of their worth.

 

Understanding the 10% Discount for Lack of Marketability (DLOM) in 409A Valuations

What is a DLOM Discount For Lack of Marketability?

Discounts For Lack Of Marketability (DLOM) is a process widely used to calculate the value of private companies’ closely held and restricted shares. The theory behind DLOM is that a valuation discount exists between a stock that is publicly traded and thus has a market and the market for privately held stock, which usually has little if any marketplace three top methods are used to quantify the discount, Restricted stock method, IPO method, and Option pricing method. Look at the factors that impact calculating the discount for lack of marketability, including:

  • Costs linked with making a public offering
  • Company redemption policy
  • Holding period for stock
  • Restrictions on transferability of shares
  • Amount of control in transferred shares
  • Company management
  • Nature of the company, which includes things like its economic outlook, history, and position in the industry
  • Private vs. Public Sale of Shares
  • Company dividend policy
  • Financial statement analysis

How to Calculate DLOM

Discounts For Lack Of Marketability (DLOM)

Private companies don’t have a market to trade their shares. It is difficult for them to sell and buy shares and lack of marketability causes these shares to have less worth. Additionally,  it is not very easy to get a discount as shared above due to the various challenges such as lack of information in a private company, mostly the pricing information. Due to this, Understanding the 10% Discount for Lack of Marketability (DLOM) in 409A Valuations makes things easier. The methods include:

Restricted Stock Method

Restricted stock refers to unregistered shares of ownership in a public company. This type of share is restricted which means it cannot be sold or transferred, which is there to deter the early selling of shares. In the restricted stock method analyze the price differences between publicly traded shares and restricted shares of a similar company.

  • Analyze Price Differences
  • Aggregate Data and Determine Average Discount
  • DLOM=(Price of Freely Traded Shares/Price of Freely Traded Shares−Price of Restricted Shares​)×100
  • Identify Comparable Transactions

Option Pricing Method

Options are rights given out to holders to purchase or sell some of the company stock at a defined rate which is the strike price and at a specific date in the future. The prices of these options can help in getting the value of a stock. This model can be used to estimate the value of liquidity restrictions.

  • Gather Inputs for the Option Pricing Model
  • Choose an Option Pricing Model (Black-Scholes Model and Longstaff Model)
  • Calculate the Put Option Value
  • DLOM=Stock Price/Put Option Value​×100

IPO Methods

Finally, the last IPO method is used to calculate the discount for lack of marketablity is. An initial public offering is when a private company offers shares to the public first time for a new stock issuance or a financial exchange. Through IPO firm get many investors and also enhance their legitimacy. The IPO method helps to calculate the price of shares sold before an IPO to the IPO price. The difference provides insights into the DLOM for shares that are not easily marketable.

  • Identify Comparable IPOs
  • Analyze Price Differences
  • DLOM=(Post-IPO/PricePost-IPO Price−Pre-IPO Price​)×100
  • Average Discount

Analyze Company-Specific Factors

Your company factors and work play an important role that influences DLOM so Understanding the 10% Discount for Lack of Marketability (DLOM) in 409A Valuation is important to get accurate and fair valuations.

  • Financial Performance
  • Industry and Market Conditions
  • Growth Prospects
  • Size of the Company
  • Restrictions on Transferability

Issues with the DLOM

Issues with the DLOM

Solving these challenges, requires a well-documented approach, leveraging both empirical data and professional judgment, which is essential for accurate and defensible valuations.

  • Subjectivity
  • Empirical data limitations
  • Company-specific factors
  • Market conditions
  • Quantitative model complexities
  • Regulatory scrutiny

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Sharp 409A has been a reputed 409A valuation provider since 2014. With the great guidance of Mr. Rajarshi Rakshit (Founder and Managing Director of Sharp 409A Software LLP). It became the first company to provide a unique Microsoft Excel-based exhaustive OPM, PWERM, and Hybrid allocation software to help firms perform IRC 409A Valuations efficiently. Additionally, they offer valuation services in more than 12+ countries and save cost and time.

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