Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
The Discount for Lack of Marketability:
Update on Current Studies and Analysis of Current Controversies
Robert Reilly* and Aaron Rotkowski**
*Managing director of Willamette Management Associates, a valuation consulting, economic analysis, and financial advisory firm with regional offices in Chicago; Atlanta; New York City; Westport; Portland; and Washington, D.C. He holds a B.S. in economics and an M.B.A. in finance, both from Columbia University.
**Associate with Obsidian Finance Group, LLC, a Portland, Oregon based private equity group. He holds a B.S. in business administration from the University of Oregon, with a concentration in finance.
The difference in price an investor will pay for a liquid asset compared to a comparable illiquid asset is often substantial. This difference in price is commonly referred to as the “discount for lack of marketability” (DLOM). That is, the DLOM measures the difference in the expected price between (1) a liquid asset (that is, the benchmark price measure) and (2) an otherwise comparable illiquid asset (that is, the valuation subject). The measurement of the appropriate DLOM continues to be a controversial topic, particularly with regard to valuations performed for gift and estate tax, shareholder litigation, buy-sell agreement, and family law purposes.This Article first summarizes the concepts of investment liquidity and illiquidity (that is, the conceptual basis for the DLOM) (Parts I and II), the empirical studies and the theoretical models that are commonly used to estimate the DLOM (Parts III, IV, and V) and the application of the DLOM to a closely held business valuation (Part VI). Then the Article analyzes the factors that influence the magnitude of the DLOM (Part VII) and the current controversies regarding DLOM analyses (Part VIII).