Meaning
Reduction applied to the value of a share of stock to account for the difficulty of selling it in a private market. A discount for lack of marketability indicates that shares in a startup cannot be easily converted to cash compared to shares in a public company. Valuation experts apply this percentage to arrive at the fair market value for tax and reporting purposes.
Illiquidity Adjustment
Liquidity is a valuable attribute that justifies a higher price for an asset. Without a public exchange or a regular secondary market, holders of private stock must wait for a specific event to exit their position. The discount for lack of marketability compensates for the risk of being unable to sell during a market downturn.
Quantification Method
Determination of the specific percentage often involves the use of restricted stock studies or option pricing models. These studies compare the price of identical shares that have different trading restrictions to find the implied cost of illiquidity. A typical discount ranges from twenty to thirty five percent depending on the expected time to an exit event.
Market Friction
Selling private shares involves administrative hurdles. Valuations for internal grants include this adjustment to stay within tax regulations.
