Brief Definition
Discount for Lack of Marketability (DLOM) refers to the reduction in the value of an investment because it is not easily sold or traded on the market. When an investment is hard to sell quickly or at a fair price, it becomes less attractive to buyers. This discount is applied to account for the difficulty in converting the investment into cash. Factors like the absence of an established market, legal restrictions, or limitations on transferability can contribute to a lack of marketability. The DLOM is a percentage reduction from the estimated fair market value and compensates buyers for the risks and extra effort associated with owning an illiquid investment.
Further Explanation
Discount for Lack of Marketability (DLOM) refers to the reduction in the value of an investment or ownership interest due to its limited marketability or the difficulty of converting it into cash quickly and at fair market value. When an investment is not easily traded or sold on the open market, it may be less attractive to potential buyers, which can result in a discount being applied to its value.
Factors that contribute to a lack of marketability include the absence of an established market, legal restrictions, or the presence of specific conditions or agreements that restrict the transferability of the investment. For example, shares of a privately held company or restricted securities that cannot be freely traded on public exchanges may experience a lack of marketability.
The DLOM is typically expressed as a percentage reduction from the estimated fair market value of the investment. The specific discount rate is influenced by various factors, including the size of the investment, the expected time required to sell it, the volatility of the investment’s value, and the prevailing market conditions.
Applying a discount for lack of marketability recognizes the potential difficulties and risks associated with owning an investment that cannot be readily sold or traded. It serves to reflect the illiquidity of the investment and compensates potential buyers for the additional time and effort required to convert the investment into cash.