Once the marketable value of the common stock is determined, an additional adjustment is often required—the discount for lack of marketability (DLOM).
This discount can be necessary because private-company equity owners typically don’t enjoy the liquidity of freely traded public securities. Generally, the DLOM declines as a company nears a liquidity event such as an IPO.
Measuring DLOM can involve highly subjective inputs, which often receive scrutiny from the SEC and a company’s auditors. Methods used to estimate the DLOM should employ generally accepted models, and management should be able to reasonably justify the inputs.
A common approach is the protective-put model. This model employs a Black-Scholes calculation to determine the cost of a hypothetical put option to provide downside protection for the holder of the company’s stock.
Important inputs for this model include an estimated time until a possible liquidity event for the company, such as an IPO or acquisition, and anticipated volatility of the company’s equity value over the time period to liquidity.