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Definition: Marketability Discount
Marketability Discount is the discount required for a company’s closely held and restricted shares which are not marketable like that of common stock. It is an amount or percentage of value that is deducted from the value of an ownership interest and is to compensate for the relative absence of marketability.
Marketability is defined as the ability to liquidate the business interest quickly with minimum transaction & administrative costs. It must involve a high degree of certainty as to the amount of net proceeds.
Business Interest is generally worth more for publicly traded company than privately held company as a ready market do exist for publicly traded ones. So in order to generate market for privately held companies (Restricted shares), concept of marketability discounts is used. Generally Marketable Discounts is referred as Discount for Lack of Marketability (DLOM).
Various methods are used to calculate the value of restricted/closely held shares like
Restricted stock method
Option pricing model
In Restricted stock method, the trading prices of a company’s publicly held stock sold on the open market is compared with those of unregistered or restricted shares of the same company sold in private transactions.
In IPO method, the percent difference between prices of shares during pre-IPO and post-IPO is calculated which gives Discount for Lack of Marketability (DLOM).
In Option pricing method, the option's price and the strike price of the option are used as the determinants of the DLOM.
Size of earnings and revenues, Industry and product risks are some of primary factors in determining the size of the DLOM. Generally, DLOM ranges between 30%-50% for any stock.
Consider a company ABC with its share value of Rs.100. If Marketability Discount of 30% is given by the company, then what is the resultant value of the share ?
Share value = Rs.100
Marketability Discount = 30%
Value of marketability discount provided = 30% of Rs.100 = Rs.30
Resultant value of the share = Rs.100 – Rs.30 = Rs.70