When assessing the value of closely held companies, valuation analysts typically include a discount for lack of marketability (DLOM). This discount reflects the fact that interest in a closely held company is difficult to “market” or sell, which reduces the value of the interest.
While the IRS acknowledges that a DLOM results in a reduced value, the agency often takes issue with the extent of the reduction in value.
An IRS job aid on the topic was made available to the valuation community several years ago. In the aid, the agency points out what it considers to be significant flaws in the widely used FMV Restricted Stock Study and discusses how courts are somewhat reluctant to accept DLOMs derived from restricted stock studies without detailed analysis of study data.
More recently, a group of valuation professionals led by respected valuation analyst and educator James Hitchner created a new reference, “Discount for Lack of Marketability Guide and Toolkit.”
The new guide is designed to help valuation analysts calculate and support the DLOMs in their valuation reports using detailed documentation of current theories, empirical studies, databases, and methodologies. It includes qualitative and quantitative methods, shareholder cash flow adjustment models, and other models, discussing the relative merits of each, along with landmark tax court cases.
The primary model in the toolkit involves restricted stock studies and allows valuation analysts to adjust restricted stock discount data based on differences in volatility, holding periods, dividends, and other factors. This is crucial input because providing adequate support for their DLOM calculations can be challenging for analysts.
While calculating DLOMs will never be an exact science, references like this new guide assist the profession by providing data and insight that analysts can use to support their valuation opinions.