In business valuation, valuation discounts are downward adjustments applied to reflect factors that reduce the value of a business interest relative to an idealized, fully marketable, fully controlling benchmark.
These discounts recognize real-world risks and frictions that affect the actual price a willing buyer would pay.
What Is a Valuation Discount?
Valuation discounts are adjustments applied during a business valuation to account for characteristics that reduce the attractiveness or liquidity of an ownership interest.
They are used when valuing partial interests, privately held businesses, or companies heavily dependent on individual owners.
The purpose is to reflect fair market value realistically, considering practical constraints like lack of control, limited marketability, or key person risks.
Proper application demands careful, case-specific analysis, not mere reliance on statistical studies or mechanical formulas.
Different Types of Valuation Discounts
There are several types of discounts used in business appraisals. Three are commonly used:
Discount for Lack of Marketability
A Discount for Lack of Marketability (DLOM) acknowledges the difficulty in selling a privately held business compared to a publicly traded company.
Unlike public shares, which can be sold instantly with minimal cost, selling a private business often involves long timelines, substantial expenses, and considerable uncertainty. Many small businesses never successfully complete a sale, even under favorable economic conditions.
Read more about DLOM
Discount for Lack of Control
A Discount for Lack of Control (DLOC) reflects the reduced value of an ownership interest that does not carry control over the business.
In theory, lack of control introduces additional investment risk — minority owners cannot unilaterally direct business policy, manage cash flows, or decide on a sale or liquidation.
However, the practical significance of control risk varies depending on company-specific factors like governance rights, shareholder protections, and industry norms.
Read more about DLOC
Key Person Discount
A Key Person Discount is used when a business’s success depends heavily on the involvement of a particular individual — typically a founder or uniquely skilled executive.
Key person dependency introduces risk that can materially affect value: if the individual were to leave, retire, or pass away, the business could suffer significant operational and financial disruption.
The existence and magnitude of any Key Person Discount should be derived from case-specific analysis, considering the depth of the management team, the transferability of customer relationships, and the durability of the brand independent of the key individual.
Read more about key person discounts
How to Apply a Valuation Discount in a Business Valuation
Valuation discounts are typically applied toward the end of the valuation process, after the fundamental value of the business or interest has been determined.
Discounts for lack of marketability, control, or key person risk should be applied based on the specific facts of the business and interest being valued.
Many compilations of studies, often based on data and market conditions from as far back as the Vietnam War era, are poor substitutes for real-world experience and pragmatic analysis. Relying on them without adjusting for the facts is not in compliance with Revenue Ruling 59-60 nor how real-world transactions work.
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