The DLOM That Was Applied Twice
You are valuing a 30% non-controlling interest in a privately held industrial distributor. The controlling-interest value (100%) has been determined at $40M enterprise value, with $2M debt and $1M cash, giving $39M equity value. The subject interest is 30%, or $11.7M on a pro-rata basis. The engagement letter specifies fair market value, non-controlling, marketable basis, but the client (a minority shareholder in a divorce proceeding) wants a "marketability discount" applied. Your draft applies a 25% DLOM and a 10% minority discount, arriving at $11.7M × 0.75 × 0.90 = $7.90M. The operating agreement contains a right of first refusal, a drag-along provision, and a buy-sell formula priced at book value. A prior valuation from three years ago used a 20% DLOM and no minority discount.
1. Is the 10% minority discount appropriate given the stated standard and premise?
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No - and the error is conceptual, not numerical.
The engagement specifies a non-controlling interest valued on a marketable basis. The starting point ($39M equity, 30% = $11.7M) is a pro-rata value of the whole. A minority discount is applied when you start from a controlling value and need to step down to a minority interest. Here you are already valuing a minority interest directly - applying a minority discount on top of a pro-rata minority value double-counts the lack of control.
Correct sequence:
- Determine the value of the subject interest on the appropriate premise (non-controlling, marketable).
- Apply a DLOM to reflect lack of marketability (if the standard requires it).
- Do not apply a separate minority discount unless the starting value was a controlling value.
The 10% minority discount should be removed. The result becomes $11.7M × 0.75 = $8.78M (before revisiting the DLOM itself).
2. Evaluate the 25% DLOM. What does the operating agreement do to the marketability analysis, and how does the prior 20% figure inform your conclusion?
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The operating agreement is the dominant fact. A right of first refusal, drag-along, and - critically - a buy-sell formula at book value mean the minority holder's realistic exit is at book, not at fair market value. That is a severe marketability restriction and arguably a value restriction, not merely a marketability one. A 25% DLOM may be too low if the buy-sell formula is binding, or the analysis may need to model the buy-sell price directly rather than apply a generic DLOM.
Prior 20%: A three-year-old 20% DLOM is a data point, not a mandate. If nothing about the company or the agreement changed, consistency argues for ~20%. If the agreement was amended to add the buy-sell formula, an increase is justified - but it must be explained, not just asserted.
Recommended approach:
- Justify the DLOM with evidence (restricted-stock studies, pre-IPO studies, or a quantitative model), adjusted for the specific restrictions.
- Consider whether the buy-sell formula caps value below the DLOM-adjusted figure. If book value is, say, $6M for the 30% interest, the DLOM-adjusted $8.78M may be unreachable and the buy-sell price becomes the binding constraint.
- Disclose the tension between the standard of value (fair market value) and the contractual reality.
3. The client is in a divorce proceeding and wants the lowest defensible value. What are your professional obligations?
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You are an independent expert, not an advocate. The client's preference for a low number is not a valuation input. Obligations:
- Independence and objectivity - the report must reflect your professional judgment, not the retaining party's desired outcome. If you cannot maintain objectivity, decline or withdraw.
- Standard of value - fair market value is defined; apply it consistently. Do not select discounts to reach a target.
- Disclosure - the report must disclose the DLOM and minority-discount rationale, the operating-agreement restrictions, and the buy-sell formula. A reader must understand why each adjustment was made.
- Consistency with prior report - if you depart from the prior 20% DLOM, explain the change. Inconsistency without explanation is a cross-examination gift.
- Documentation - every adjustment must be traceable in the workpapers.
Practical note: the correct answer here happens to be higher than the client wants (removing the minority discount raises value). Deliver the defensible number and explain the reasoning. If the client pressures you to keep the minority discount, that is a red flag about the engagement.