Meaning
Valuation adjustments reduce the estimated worth of an ownership interest that cannot be easily or quickly converted to cash. Applying a discount for lack of marketability reflects the reality that shares in a private company are harder to sell than those on a public exchange. This reduction is applied after the initial fair market value is calculated to account for the liquidity risk.
Liquidity Restriction
Inability to find a buyer or a secondary market for a minority stake decreases the attractiveness of the asset. Under the rules for a discount for lack of marketability, the appraiser looks at the time it would take to complete a sale and the cost of finding a counterparty. Investors demand a lower price to compensate for the fact that their capital is locked into the business for an indefinite period.
Transfer Barrier
Contractual limits such as rights of first refusal or board approval requirements for share transfers further lower the value. When a discount for lack of marketability is determined, these legal hurdles are weighed against the freedom of a public shareholder to sell at any time. The more restrictive the shareholder agreement, the higher the percentage reduction from the base value.
Minority Interest
Lack of control over the company’s direction and dividend policy adds another layer of risk for the holder. While a controlling stake might avoid a discount for lack of marketability, a small holding has no power to force a sale or a distribution. This lack of influence means the holder is entirely dependent on the majority owners for any future return on investment, which justifies a deeper cut to the valuation than would be seen in a transaction for the entire company or a controlling interest.
