Discounts, Premiums, and Adjustments
Core concepts
After an indicated value, adjust for level of value and marketability. The value spectrum runs from a controlling, marketable interest to a minority, nonmarketable interest. Control premium applies when moving from minority to control; discount for lack of control (DLOC) is its inverse: DLOC = 1 − [1 ÷ (1 + control premium)]. Discount for lack of marketability (DLOM) reflects the cost and time to convert an interest to cash-supported by restricted stock studies, pre-IPO studies, and option-pricing models (e.g., protective put).
Apply discounts and premiums in a logical sequence, and avoid double counting-do not apply a DLOC for a right already reflected (e.g., a control-level cash flow). Other adjustments: key person discount, blockage, portfolio discount, and voting vs. nonvoting differences.
Traps
- Applying a DLOM to a controlling interest at the same magnitude as a minority interest.
- Stacking a control premium and a DLOC in the same direction.
- Converting premium to discount incorrectly (see formula).
- Applying discounts to an already minority, marketable base and then again for control.
- Assuming DLOM is fixed; it varies with the interest, the company, and market conditions.
Worked rule of thumb
Control premium 30%. DLOC = 1 − (1 ÷ 1.30) = 23.1%. A $1,000,000 minority value grossed up for control = $1,300,000; a $1,300,000 control value discounted to minority = $1,000,000. A 25% DLOM on a $1,000,000 minority interest yields $750,000.
Exam strategy
State the level of value of the pre-adjustment indication, then apply only the adjustments needed to reach the subject interest's level.