Valuation Methodology

DLOM Deep Dive: Discount for Lack of Marketability in 409A Valuations

FairValueX Team · 10 min read

What Is DLOM?

DLOM reflects the price reduction that a buyer would demand for purchasing shares that cannot be easily sold on a public exchange. Private company shares are illiquid — there's no stock market to sell them on, no daily quoted price, and limited transfer rights. A buyer of private shares accepts more risk than a buyer of publicly traded shares, and the DLOM quantifies that difference.

In a 409A valuation, DLOM is applied to the marketable minority value of common shares (the value derived from enterprise valuation and equity allocation) to arrive at the fair market value (FMV) — the number used as the strike price for stock option grants.

Why Auditors Scrutinize DLOM

DLOM is inherently judgmental: a 5% difference in DLOM can change the per-share value by thousands of dollars and affect the stock-based compensation expense in your P&L. Auditors focus on DLOM because:

• It's one of the largest single adjustments in the valuation
• The method and inputs involve significant professional judgment
• It directly affects whether stock options were priced at or above FMV (safe harbor compliance)
• PCAOB has flagged DLOM documentation as a common deficiency area

DLOM Methods

1. Finnerty Model (Put Option Approach)

John Finnerty's model treats the marketability restriction as an Asian put option — the cost of holding an asset that cannot be sold. The model inputs include volatility, time to liquidity, and the restriction period.

2. Chaffe Model

The Chaffe model treats DLOM as the cost of a European put protective put option on the restricted shares. It's simpler than Finnerty but has been criticized for potentially overstating DLOM in some scenarios.

3. Restricted Stock Studies

These empirical studies examine the price discount observed when restricted (unregistered) shares of public companies were sold in private transactions vs. their public market price. Key studies include:

• SEC Institutional Investor Study (1966-1969): Average discount of 26%
• Maher (1976): Average discount of 35%
• FMV Opinions (2008): Average discount of 20-25%
• Stout Risius Ross (Silber Study): Average discount of 34%

These studies provide benchmarking data but were conducted under different market conditions than today. Most valuators use them as supporting evidence rather than the primary method.

4. IPO Studies (Pre-IPO Transaction Approach)

These studies compare the price of shares in private transactions before an IPO to the eventual IPO price. The Emory and Willamette studies are the most cited, showing average discounts of 40-50% for transactions 1-5 months before IPO.

However, these studies have significant methodological limitations and are less commonly used as primary DLOM support in modern practice.

Factors That Affect DLOM Magnitude

Common DLOM Ranges by Stage

Best Practices for DLOM Documentation

• ✓ Use a quantitative model (Finnerty or Chaffe) as the primary method — not just benchmarking to studies
• ✓ Cross-reference with restricted stock studies for reasonableness check
• ✓ Document each input to the DLOM model with source and rationale
• ✓ Include sensitivity analysis showing how DLOM changes with ±10% volatility and ±1 year time-to-liquidity changes
• ✓ Be consistent period-to-period. Dramatic DLOM changes without corresponding changes in circumstances will be questioned.