This is the third in a series of five articles regarding the title above. When valuing a minority interest in a privately held company two common adjustments are made after determining the controlling fair market value of the entity. These adjustments are the Minority Interest Discount adjustment and the Discount for Lack of Marketability (DLOM) adjustment. This article explores issues associated with the DLOM associated with a minority interest to help address conflicts or disputes with IRS valuers and agents. These can be very material leading to significant conflicts. The results can lead to discussions with their immediate supervisor and in the instances of an unagreed case to Appeals at the IRS. The purpose of this article is to highlight and introduce ways to minimize these conflicts.

What is DLOM?

DLOM is an amount or percentage deducted from the value of ownership interest to reflect the relative absence of marketability. In its simplest form after determining the controlling fair market value of a  privately held firm two discounts are applied to determine the nonmarketable minority interest. The first is the minority discount. The minority discount reflects that a minority interest does not have the prerogatives of control that a controlling interest has. After applying the minority discount this give a value known as the marketable minority interest. However, the question remains how liquid or marketable is this interest? That is how quickly might this minority shareholder be able to sell this interest or if at all? There is no direct way to measure what the DLOM may be for a privately held entity, so a series of proxy methods are used in the development of the DLOM. Once the DLOM is applied to the marketable minority Interest the result is the nonmarketable minority interest.

IRS Job Aid on DLOM

The IRS developed a DLOM Job Aid for its valuers in 2009. This author championed the Job Aid to help provide guidance and allow for greater consistency for the 420 employees in the IRS Engineering Program that may be involved with business valuation at the time. The IRS identified 25 subject company factors and 5 subject interest factors in the published Job Aid. The IRS also broke various studies into four broad categories as benchmark approaches, securities based approaches, analytical approaches, and other approaches. Associated with each approach the Job Aid offers information on nearly twenty methods. Information on various methods may include background information, areas of focus, strengths, weaknesses ,a summary,  important parameters, prevalence in professional practice, and what the courts have to say about this approach. This information can prove very valuable when commenting on various methods in a conclusion of DLOM by a valuer.

An update to the Job Aid

Speaking with IRS officials there is no plan to update the original study, and there is a concern that taking down the study off the internet may raise questions, so the original study remains. The following is this author’s perception of which methods the IRS may consider more positively in general. The specifics in any case should govern. Note that for Pluris this does not include the methodology that includes warrants. This methodology is proprietary to Pluris and cannot be audited. Valuers are encouraged not to use a black box approach. Here are recommendations based on my experiences as a valuer for over 30 working for the IRS and over 10 years’ experience in the private sector.

Holding Companies

Operating Companies

Small Entities

Large Entities

Going Public

FLPs and 1120s

Restricted Stock Studies

GPCM - Longstaff

A tool to help you

I found the most comprehensive and complete text on this subject coupled with its toolkit is the Discount for Lack of Marketability Guide and Toolkit by James R. Hitchner, R. James Alerding, Joshua B Angell and Katherine E. Morris. The guide covers:

• Description of DLOM approaches and methods from past and present
• Presentation and analysis of historical DLOM studies
• Summary of different option methods
• Case studies illustrating application of different methodologies
• Analyses of restricted stock transaction databases
• Summaries of relevant court cases

The GUIDE includes two case studies that take you through an easily understandable and transparent process for determining a supportable DLOM. The GUIDE includes an in-depth discussion on the following studies, databases, models, and methods:

• Legacy restricted stock benchmark studies
• FMV Opinions detailed restricted stock database
• Pluris detailed restricted stock database
• Legacy pre-IPO benchmark studies
• Valuation Advisors detailed pre-IPO database
• Quantitative marketability discount model (QMDM)
• VPS DLOM Toolkit
• Option pricing models
  • Black-Scholes/Chaffe
  • Longstaff
  • Finnerty
• Analytical methods
• Wruck
• Hertzel and Smith
• Bajaj, Denis, Ferris, and Sarin
• Abbott
• Ghairdarov
• Katsanis
• Long-term equity anticipation securities (LEAPS)
• NERA CAPM
• Mandelbaum-type analyses
• IRS DLOM Job Aid – Discount for Lack of Marketability Job Aid for Valuation Professional
•  

Want to know more?

Check out three sources to help you. Business Valuations and IRS: Five Books in One is a comprehensive text that addresses a host issues including an update on DLOMs. This text is now available on Amazon from the publisher directly at a discount. This text is an update from an original text focusing strictly on DLOMs with information only know five years early entitled Discount for Lack of Marketability and the IRS. As a third way to assist you I offer you a complimentary eBook that addresses about 1/3 of the information from Business Valuations and the IRS text as it relates only to DLOMs. The eBook has over 20 links to help you.

There are no guarantees in life. An individual agent or IRS valuer has their own opinion too. I am offering this information for educational purposes only as a way to update you and give you information for your consideration that I thought could help you.