A discount for lack of marketability reduces the indicated value of an ownership interest to reflect that it cannot be converted to cash quickly, at a known price, through an established market. Shares of a closely held company have no exchange to sell on, often carry transfer restrictions, and may wait years for a buyer, and a hypothetical purchaser pays less for them than for an otherwise identical interest that could be sold tomorrow. This guide explains what the discount measures and what it does not, which standards of value permit it and which exclude it, the evidence the economist draws on to size it for the specific interest, how it is kept separate from the discount for lack of control, how it is handled in divorce, shareholder, and damages matters, and where opposing valuations go wrong when they apply it.
Marketability is the ability to sell an interest quickly, at a price close to its indicated value, with little cost and little uncertainty about when the cash arrives. A share of a publicly traded company has it: the holder can sell at the quoted price within a day. An interest in a closely held company does not: there is no exchange, no quoted price, and no assurance that a buyer exists at any price, and the operating agreement or the shareholders' agreement may restrict to whom and on what terms the interest can be transferred. The discount for lack of marketability is the reduction a buyer demands for taking on that illiquidity, and it is applied after the income, market, or asset approach has produced a value for the interest as if it were freely tradable.
The discount is a feature of the interest, not of the company. A profitable, well run business can carry a large marketability discount on a minority block because the block cannot be sold, while the company as a whole could be sold in a transaction that takes months rather than minutes. That distinction is why the discount is applied at the level of the interest being valued, and why the report states the level of value the approaches produced before the discount was taken, so the reader can see what the discount is being applied to and whether that base already reflects some illiquidity.
Whether the discount belongs in the valuation at all depends on the standard of value the law or the agreement imposes, and that is a legal question the business valuation report takes from counsel rather than decides. Under fair market value, the price a hypothetical willing buyer would pay a hypothetical willing seller, the discount is ordinarily considered, because a real buyer of an illiquid interest would demand it. Under the fair value standard most states apply to dissenting shareholder appraisals and oppression buyouts, the discount is usually excluded, because the departing owner is not a willing seller to an outsider and the remaining owners are not buying a block they cannot sell. The fair value versus fair market value comparison sets out the two standards in the shareholder setting.
Divorce courts split. Some treat the marital interest at fair market value and allow the discount; others reason that the owner spouse is keeping the business, not selling it, and exclude a discount for a sale that will not happen; a third group allows it only where a sale is actually contemplated or the restrictions are real. The general comparison of the two standards covers the definitions. Where the governing standard is unsettled, the report shows the value with and without the discount, so that the court can apply whichever rule it adopts to a number built for that rule rather than argue the law from a figure built for the other one.
The size of the discount is not a convention; it is an estimate for the specific interest, and the report shows the evidence it rests on. The empirical base comes from two kinds of studies: comparisons of the prices at which restricted shares of public companies, which could not be sold for a holding period, traded against the same company's freely traded shares; and comparisons of the prices paid for shares in private transactions before an initial public offering against the offering price. Both measure what buyers paid to accept a period of illiquidity, and both have known limits that the report acknowledges: the restricted stock studies measure a defined holding period that a closely held interest may not have, and the pre-offering studies include companies whose offering was already in prospect.
From that base the economist moves to the interest in hand. The factors that raise the discount are a long expected holding period, transfer restrictions in the governing agreement, no history of distributions, no prospect of a sale or a public offering, a small block, a company whose earnings are volatile, and a pool of buyers limited to the other owners. The factors that lower it are a put right or a buy-sell agreement that creates a buyer at a formula price, regular distributions that pay the holder while they wait, a company being marketed for sale, and a block large enough to influence a sale. Option pricing models, which price the cost of protecting against a decline in value during the holding period, give a second, independent read on the discount from the interest's own volatility and expected holding period, and a report that reconciles the two reads has shown its work.
A minority interest in a closely held company often carries two discounts, and they measure different things. The discount for lack of control reflects that the holder cannot set compensation, declare distributions, sell the company, or change its direction, and it is applied when the approaches produced a value at the control level. The discount for lack of marketability reflects that the holder cannot sell, and it applies whether or not the holder has control, though a controlling owner, who can sell the whole company, usually bears a far smaller one. The two are applied in sequence, control first and then marketability on the reduced base, because a buyer decides what the block is worth to hold before deciding what to deduct for the difficulty of selling it.
Keeping them separate matters for two reasons. First, the evidence differs: control discounts are drawn from the premiums paid in acquisitions of public companies, marketability discounts from the restricted stock and pre-offering studies, and a report that cites one body of evidence for both has priced one of them twice or not at all. Second, the law treats them differently in some settings; a court applying fair value may reject a control discount on the ground that the shareholder is entitled to a proportionate share of the whole while allowing a marketability discount at the enterprise level, or the reverse, and the report has to be able to remove either one without disturbing the other. The business valuation in litigation guide describes where each adjustment sits in the valuation.
In a divorce, the discount is contested because it moves the marital estate directly and because the sale it assumes will usually not occur. The economist states the standard the venue applies, values the interest with and without the discount, and ties the factors to the agreement and the distribution history in the record. Where the business carries personal goodwill, the goodwill allocation is made before any discount is considered, so that the same illiquidity is not removed twice, once as goodwill that leaves with the owner and once as a discount on what remains.
In a shareholder dispute venued in a New Jersey court, or in any venue, the fair value standard usually governs and the discount is usually excluded, but a buy-sell agreement that fixed fair market value as its measure can bring it back, and the report presents both figures. In a damages matter, where an owner's interest was destroyed or impaired, the discount enters only if the measure of loss is the value of the interest rather than a stream of lost profits, and the lost profits versus lost business value guide explains how that choice is made. An estate or gift tax valuation applies fair market value by definition and nearly always carries the discount, but that setting lies outside litigation and is noted here only because its case law is the source of much of the evidence the litigation reports rely on.
The errors fall into a short list. A discount applied under a standard of value that excludes it, or omitted under one that requires it, with no statement of the standard. A figure asserted from a range the studies report without tying it to the interest's holding period, restrictions, distributions, or prospects for sale. A marketability discount applied to a controlling interest at the same rate as a minority block. Control and marketability discounts drawn from the same evidence, or applied in parallel to the undiscounted base rather than in sequence. A discount taken against a value the market approach already produced from transactions in illiquid private companies, so the illiquidity was removed twice. A discount applied to an interest the agreement gives a put right at a formula price, which is a buyer the discount assumes does not exist.
Each of these is visible on the face of the report and each can be tested against the agreement, the distribution history, and the studies cited. On the other side, a report that rejects every discount as speculative without engaging the evidence of illiquidity the agreement and the record show has left the question unanswered. The rebuttal guide lists the questions that expose both failures, and the report review service describes how an opposing valuation's discounts are tested one factor at a time.
Sometimes, but at a much smaller rate than for a minority block. A controlling owner can sell the whole company, so the illiquidity is the time and cost of marketing a business rather than the absence of any buyer. Whether any discount applies at the control level depends on the standard of value and the venue's case law, and the report states the treatment it adopted.
Studies of the price difference between restricted and freely traded shares of the same public company, studies of private share sales before a public offering, and option pricing models that price the cost of waiting out the holding period. The economist then moves from that base to the interest at hand on the transfer restrictions, distribution history, expected holding period, and prospects for a sale shown in the record.
Usually, because a right of first refusal, a consent requirement, or a bar on transfer to outsiders narrows the pool of buyers and lengthens the wait. A restriction paired with a put right or a buy-sell formula can cut the other way, since it creates a buyer at a stated price, and the report reads the agreement for both effects before sizing the discount.
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