How do you estimate the appropriate discount for a private company valuation?
CFA Level II discusses applying discounts when valuing private companies. There's a discount for lack of marketability (DLOM) and a discount for lack of control (DLOC). How are these estimated and when do you apply each?
Private company valuation requires adjustments that public company analysis doesn't because private shares are inherently less liquid and may not come with controlling rights.
Discount for Lack of Marketability (DLOM):
Private company shares cannot be easily sold on an exchange. This illiquidity means buyers demand a discount. The DLOM compensates for:
- Higher transaction costs to find a buyer
- Longer time to execute a sale
- Greater uncertainty about realizable price
- Inability to quickly exit the position
Estimation methods:
| Method | Approach | Typical DLOM Range |
|---|---|---|
| Restricted stock studies | Compare prices of restricted (non-tradeable) shares vs. freely traded shares | 15-35% |
| Pre-IPO studies | Compare private transaction prices to subsequent IPO prices | 25-50% |
| Option pricing models | Model illiquidity as the cost of a put option (Chaffe, Longstaff) | 10-30% |
Discount for Lack of Control (DLOC):
A minority stake in a private company lacks the ability to:
- Set dividends or distributions
- Hire/fire management
- Decide on acquisitions or divestitures
- Determine capital structure
The DLOC is typically estimated from the inverse of the control premium observed in public company takeovers:
DLOC = 1 - (1 / (1 + Control Premium))
If average control premiums are 30%: DLOC = 1 - (1/1.30) = 23.1%
Application framework:
| Starting Point | Discounts Applied |
|---|---|
| Public company comparable → Minority, marketable value | Apply DLOM only |
| DCF of total equity (control value) | Apply DLOM + DLOC for minority interest |
| Precedent transactions (control, marketable) | Apply DLOM + DLOC for minority interest |
Example: Greenleaf Capital values Thornberry Manufacturing using public comparables at $120M (this reflects a minority, marketable value). To arrive at the value of a 15% minority stake:
- Apply DLOM of 25%: $120M × (1 - 0.25) = $90M
- 15% stake: $90M × 15% = $13.5M
Note: No DLOC is applied here because the public company comparables already reflect minority values.
Exam tip: The CFA exam tests the order of applying discounts and from which base value. The most common mistake is double-counting — applying DLOC when the starting valuation already reflects a minority position.
Explore equity valuation on AcadiFi's CFA Level II platform.
Master Level II with our CFA Course
107 lessons · 200+ hours· Expert instruction
Related Questions
What exactly is the Capital Market Expectations (CME) framework and why does it matter for asset allocation?
How do business cycle phases affect asset class return expectations?
Can someone explain the Grinold–Kroner model step by step with numbers?
How do you forecast fixed-income returns using the building-blocks approach?
PPP vs Interest Rate Parity for forecasting exchange rates — when do I use which?
Join the Discussion
Ask questions and get expert answers.