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Subject 8. Valuation Discounts and Premiums PDF Download
If 100% of a private company is worth $10 million, a 10% ownership interest in that business may not be worth $1 million and is probably worth significantly less. Why?

Control and marketability issues are important and challenging elements in the valuation of private companies and equity interests therein.

Lack of Control Discounts

If publicly traded companies are used as the basis for pricing multiples, control premiums may be appropriate in measuring the value of the total equity of a private company. Control premiums have also been used to estimate lack of control discounts.

A non-control interest, in most cases, is worth less per share than a control interest. A discount for lack of control (DLOC) is the amount deducted from the pro rata share of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control. It is used to convert a controlling interest value into a non-controlling equity interest value.

DLOC = 1 - [1 / (1 + Control premium)]

Evidence of the adverse impact of the lack of control is an important consideration in assessing this discount.

Lack of Marketability Discounts

For shareholders who own a minority interest in a closely-held company, their stock tends to be much less marketable and its value is reduced accordingly. The marketability - the liquidity - of stock shares is a concept that is distinct from the level of control, but related to it.

Discounts for lack of marketability (DLOM) are used in the valuation of non-controlling equity interests in private companies. A DLOM may not be appropriate if there is a high likelihood of a liquidity event in the immediate future.

Quantifications of DLOM can be challenging because of limited data, differences in the interpretation of available data, and different interpretations of the impact of the lack of marketability on a private company.

Methods that have been used to quantify the DLOM include:

  • The restricted stock method. It purports that the only difference between a company's common stock and its restricted stock is the lack of marketability of the restricted stock. Subsequently, the price difference between both units should arise due to this lack of marketability.
  • The IPO method. It relates to the price difference between shares that are sold pre-IPO and post-IPO. The percent difference between the two prices is considered the DLOM using this method.
  • The option pricing method. The option pricing method uses the put option's price and the strike price of the option as the determinants of the DLOM. The option price as a percentage of the strike price is considered the DLOM under this method.

DLOC and DLOM are multiplicative rather than additive. That is, they are taken in sequence. Assume a 30% DLOC and 40% DLOM, and a control value of $10 per share.

  • Control value of $10 - $3 lack of control discount (10 x 0.3) = $7 (marketable minority value).
  • $7 - $2.8 lack of marketability discount (7 x 0.4) = $4.2 (per share value of non-marketable minority shares).
  • The total discount is then 58%. (1 - 0.7 x 0.6)

Learning Outcome Statements

explain and evaluate the effects on private company valuations of discounts and premiums based on control and marketability;

CFA® 2023 Level II Curriculum, Volume 4, Module 27

User Contributed Comments 3

User Comment
rhardin Wouldn't "taken in sequence" mean additive and not multiplicative?
arudkov i think no. bcz u shold multiply, not sum them.
olympria What they mean by additive is : [10 - (30% of 10)] = 7

And then [7 - (40% of that 7)] = 4.2

This can be written as 10 x (1-0.3) x ( 1-0.4) which is multiplicative
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I used your notes and passed ... highly recommended!
Lauren

Lauren

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