Marketability discounts commonly apply when valuing minority interests in closely held businesses, but many valuation experts believe they may also apply to controlling business interests. These discounts reflect the uncertainty and risk associated with the timing of a sale and the final price. Here’s a closer look at the issue. 
Minority Interests
In business valuation, “marketability” refers to how quickly and easily an asset converts into cash at minimal cost. Publicly traded stocks are highly marketable, but interests in private companies often require more time, effort, and expense to sell. Therefore, when valuing private businesses using public stock data, a discount often applies to reflect the lack of marketability.
Marketability discounts are well established when valuing minority (noncontrolling) interests in closely held businesses, which lack control. Numerous studies, including restricted stock and pre-IPO studies, quantify these discounts. They demonstrate the price difference between freely traded shares and less marketable shares that are either restricted or not yet publicly traded. These discounts generally range from 30% to 45%.
Controlling Interests
Applying marketability discounts to controlling interests is more controversial, although courts sometimes accept them. Most valuation experts agree that the size of these discounts should decrease as the level of control increases. However, while many argue that controlling interests should still carry some discount, others believe marketability discounts shouldn’t apply at all to such interests.
Controlling interests take time and effort to sell, which is why discounts applied to these interests are often called “illiquidity” discounts, distinguishing them from those used for minority interests. The rationale for applying such a discount is that fair market value represents a cash-equivalent concept, while the future sale of a controlling interest is uncertain, expensive, and could involve noncash terms like employment contracts or installment payments.
For instance, in a divorce case, it might seem unfair for one spouse to receive a $1 million interest in an illiquid business while the other receives $1 million in liquid assets like cash or real estate.
When calculating illiquidity discounts, experts take into account the time, cost, and risks involved in selling a business or a controlling interest in it. They may also consider the expenses of going public. While no empirical data supports marketability discounts for controlling interests, experts generally agree that these discounts should be smaller than those for minority interests.
Recent Case Example
A 2024 decision by the Court of Appeals of Iowa offers a real-world example. In In re the Marriage of Baedke (No. 23-0219, Iowa Ct. App., 2024), the court upheld a 10% marketability discount on the value of a garden center in the marital estate. Both parties had hired experts to value the business, and the court accepted the value provided by the husband’s expert, which included the discount.
The expert argued that, unlike stocks, a business cannot quickly convert to cash, and that selling a private company incurs transaction costs. The wife’s expert opposed the discount but acknowledged during cross-examination that the 10% figure was “conservative.” The appellate court ruled that the district court’s use of the marketability discount was in line with Iowa precedent, and it didn’t result in an unfair division of assets.
We Can Help
The application of marketability discounts involves professional judgment and can vary widely from case to case. If you need assistance in supporting or challenging the use of a marketability discount, contact us for expert guidance.
