In the world of finance and asset valuation, liquidity—or the ability to quickly sell an asset at or near its market value—is crucial. A marketability discount reflects the reduction in value assigned to assets that are hard to sell or convert to cash promptly without financial loss.
Typically, this discount applies to shares of privately held companies, restricted stocks, or other assets that lack an active public market. For example, while publicly traded shares of companies like Microsoft can be sold almost instantly on exchanges, privately held shares require finding a buyer, negotiating terms, obtaining approvals, and completing legal processes—steps that add time and risk.
Appraisers use several empirical methods to calculate this discount, relying heavily on studies comparing prices of restricted shares versus freely traded ones or pre-IPO stock prices against post-IPO prices. Marketability discounts often range from 5% to over 40%, varying based on specific factors.
Key factors influencing the size of the marketability discount include:
- Company Profitability: More profitable companies tend to have lower discounts due to higher desirability.
- Dividend Payments: Regular dividends improve cash flow for shareholders, reducing discounts.
- Size of Ownership Stake: Larger or controlling stakes typically command lower discounts than small, minority positions.
- Transfer Restrictions: Limitations in shareholder agreements can increase the discount due to reduced marketability.
- Prospects for Sale or IPO: Pending liquidity events like a sale or Initial Public Offering may lower the discount.
An important distinction is between marketability discount and minority discount (or Discount for Lack of Control). While a marketability discount addresses liquidity challenges, a minority discount reflects the reduced control a small shareholder has over company decisions. Often, both discounts are applied together when valuing non-controlling interests in private companies.
Marketability discounts have significant implications in estate and gift tax valuations. For instance, when gifting shares of a private company, applying a justified marketability discount can lower the taxable value, potentially resulting in substantial tax savings. However, because the IRS closely scrutinizes these discounts, a professionally prepared appraisal with supporting evidence is essential.
For further guidance on valuation discounts, see related topics such as Minority Discount and Valuation Discount.
References:
- IRS Job Aid: Discount for Lack of Marketability
- Estate Planning: The Powerful Impact of Valuation Discounts, Forbes, 2021
- Investopedia: Valuation of Non-Fungible Assets
For additional insight into valuation approaches, review IRS guidance and consult with qualified appraisal professionals.