A discount for lack of marketability is often applied when carrying out accounting valuations of securities and financial instruments. Rob Arthur and Yudmila Adaya outline core challenges such as determining when a DLOM is appropriate and how to estimate it.

A discount for lack of marketability (DLOM) is applied when assets are being valued, specifically relating to private companies that aren't traded on public exchanges and are therefore difficult to sell.

When considering applying a DLOM, there are two accounting standards that come into play: IFRS 2 and IFRS 13. IFRS 2 is about share-based payments while IFRS 13 focuses on all other financial instruments. You need to consider a range of factors when applying the discount.

Estimating DLOM: benchmarking v option pricing models


This involves analysing transactions to determine the applicable discounts. There are two primary models: restricted stock studies and pre-IPO studies. The former assesses the price discounts on sales of restricted shares, which are shares (of publicly traded companies) that aren't registered for trading on the stock exchange. The latter assesses the price discounts on private stock sale transactions that occur prior to an initial public offering (IPO).

On average, restricted stock studies suggest a discount of around 20-35%, while pre-IPO studies suggest a discount ranging from about 40-60%. However, both types of studies demonstrate that discounts can vary significantly. For example, some restricted stock studies have observed discounts as high as 90%. This emphasises the importance of considering company-specific factors when determining applicable discounts.

Option pricing models

This approach estimates the discount based on factors such as the time period until they can be sold and the volatility of the instrument. The most common option pricing models to estimate a DLOM are as follows:

  • The Chaffe model
  • The Longstaff model
  • The Finnerty model
  • The Ghaidarov model
  • The Ghaidarov forward-starting put model

There are pros and cons associated with each of these models. For instance, the Chaffe and the Longstaff models tend to result in a high DLOM when volatilities are higher, whereas the Finnerty and the Ghaidarov models tend to produce a minimum DLOM. The Ghaidarov forward-starting put model offers the benefit of allowing the investor to fix the exercise price at any point during the holding period hence the investor’s timing skills don’t need to be known.

You should consider both benchmarking and option pricing models to calculate a DLOM.

Applying a DLOM for financial instruments under IFRS 13

Under IFRS 13, fair value is defined as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date". The lack of marketability matters in fair value measurement because it introduces an additional layer of risk to potential buyers. Hence market participants would demand to be compensated for this additional risk.

Introducing a DLOM would acknowledge the challenge involved in selling an unmarketable financial instrument.

There are several key considerations on whether to apply a DLOM under IFRS 13. One is determining whether the restrictions that make your instrument unmarketable are a part of its characteristics. For example, restrictions that are explicitly stated in the terms and conditions of the instrument are part of the instrument characteristics. If the restrictions aren't part of the instrument characteristics, a DLOM would not be applicable.

You should also evaluate whether your financial instrument is truly unmarketable. An unmarketable financial instrument is usually illiquid, making it unsellable on the stock market and untransferable to other individuals.

Applying DLOM for share-based payments

Share-based payments are often subject to pre-vesting restrictions. Pre-vesting restrictions are conditions placed on the share-based payments granted that limit the recipient’s ability to sell or transfer them for a certain period. These restrictions are often tied to performance, time passing or an exit event occurring.

In scenarios where pre-vesting restrictions are in place and restrictions only apply to unvested shares, applying a DLOM is not appropriate.

The key is distinguishing between a restriction that applies only to an unvested share and one which applies to a vested share. A DLOM will only be appropriate if the restrictions apply to a vested share.

Four steps to take when deciding to apply DLOM 

1 You should be clear on your accounting standard – are you valuing under IFRS 2 or IFRS 13?

2 If you're valuing under IFRS 2 – check if there are pre-vesting restrictions as a DLOM is not applicable for restrictions during the vesting period. If pre-vesting restrictions are in place, any consideration of DLOM should only apply for restrictions applicable after the vesting period has ended.

3 Understand the tools available to estimate DLOM – while restricted stock studies and pre-IPO studies provide average discounts of around 20-35% and 40-60% respectively, discounts can vary significantly based on company-specific factors. Therefore, it's essential to consider both benchmarking and option pricing models to calculate a DLOM.

4 Documentation is key – proper documentation of the valuation process and the rationale for the application of a DLOM is crucial.

To learn more about applying the discount for lack of marketability, contact Rob Arthur.