Discount for Lack of Marketability (DLOM)

What Is a Discount for Lack of Marketability?

A discount for lack of marketability (DLOM) is a percentage reduction applied to the valuation of private company stock to account for the fact that these shares cannot be easily sold on a public exchange. Unlike public company stock, which can be sold instantly on a stock exchange at a quoted price, private company shares are illiquid — there is no ready market, sales are restricted by the company (through rights of first refusal and transfer restrictions), and finding a buyer requires significant effort and time.

The DLOM recognizes that a rational buyer would pay less for an asset that cannot be quickly converted to cash. Independent 409A valuation firms apply a DLOM when determining the fair market value of common stock at private companies, which directly affects the exercise price of stock options granted to employees.

How DLOM Is Determined

Common Methodologies

Valuation firms use several approaches to estimate the DLOM:

• Restricted stock studies: Comparing the prices of restricted (unregistered) shares to freely tradeable shares of the same company. Historical studies have shown discounts ranging from 15% to 45%.
• Pre-IPO studies: Comparing the prices of private company shares in pre-IPO transactions to the eventual IPO price. These studies typically show discounts of 30% to 50% for transactions two or more years before the IPO.
• Option pricing models: Using put option pricing to estimate the cost of illiquidity. The DLOM is modeled as the cost of a put option that would provide a guaranteed exit — a higher cost implies a higher discount.
• Quantitative Marketability Discount Model (QMDM): A discounted cash flow approach that models expected holding period, expected return, and risk to derive a discount.

Typical Ranges

Most 409A valuations for private companies apply DLOMs in the range of:

• Very early stage (pre-revenue): 25% to 45%
• Early stage (some revenue, no profitability): 20% to 35%
• Growth stage (significant revenue, approaching profitability): 15% to 30%
• Late stage (profitable or near-IPO): 10% to 20%

As a company matures and approaches an IPO or other liquidity event, the DLOM decreases because the expected holding period before liquidity shortens.

Practical Implications for Startup Employees

DLOM Benefits You at Grant Time

A larger DLOM means a lower 409A fair market value, which means a lower exercise price on your stock options and a smaller spread at exercise (reducing your tax liability). In this sense, the DLOM works in your favor — it keeps the FMV of your company's common stock below what the shares might trade at on a public market.

DLOM Decreases as IPO Approaches

As your company matures and approaches a liquidity event, the DLOM applied in 409A valuations will decrease. This means the 409A FMV per share increases even if the company's fundamental valuation stays the same. The decreasing DLOM is one reason why exercise prices on option grants tend to increase significantly in the two to three years before an IPO.

Impact on Exercise Planning

If you are considering exercising options, the current DLOM affects the FMV and therefore your tax exposure. Exercising when the DLOM is still large (and the FMV is lower) can result in a smaller AMT adjustment for ISOs or less ordinary income for NSOs. As the DLOM shrinks closer to an IPO, the FMV rises and the tax cost of exercising increases.

Not a Guarantee of Real-World Discount

The DLOM is a valuation concept, not a market reality. You cannot sell your shares for the 409A value plus the DLOM — the FMV already reflects the discount. The DLOM merely explains why the 409A value is lower than the per-share price implied by the company's latest funding round (which prices preferred stock, not common stock, and reflects a different set of rights and preferences).

How It Relates to Exercising Stock Options

The DLOM directly affects your exercise economics. A higher DLOM reduces the 409A FMV, which reduces the spread at exercise and the associated tax bill. For early-stage employees considering early exercise with an 83(b) election, a large DLOM can make the economics especially favorable — the tax cost at exercise is low because the FMV is discounted, but at exit (when the DLOM disappears and shares are liquid), your gains are taxed at long-term capital gains rates or potentially excluded under QSBS. Understanding DLOM trends at your company helps you identify the optimal exercise window before the discount shrinks.