DLOM in 409A Valuations: How the Discount for Lack of Marketability Is Calculated and Defended

A discount for lack of marketability, or DLOM, reduces the value of private-company shares to reflect the cost and risk of holding stock that you cannot readily sell. In a 409A valuation, that discount affects the fair market value of common stock, which in turn affects the strike price for stock options.

For founders, CFOs and finance teams, DLOM matters because an unsupported discount may draw questions from auditors, tax advisers or investors. A defensible discount ties the company’s facts to accepted valuation methods, documents the assumptions and explains why the final conclusion fits the expected time to liquidity.

What the Discount for Lack of Marketability Means in a 409A Valuation

Once you know 409A centers on fair market value, DLOM answers a narrower question: how much less would an investor pay for a private share that lacks a ready market?

Public-company stock usually gives investors a path to sell quickly. Private-company common stock often comes with transfer limits, no active trading market, uncertain exit timing and information gaps. The discount for lack of marketability converts those real limits into a valuation adjustment.

That adjustment does not exist to push the option strike price lower. It exists to reflect the economic disadvantage a holder accepts when they own stock that may stay illiquid until an IPO, acquisition, tender offer or other exit. Treasury regulations under Section 409A generally require stock options to carry an exercise price at least equal to fair market value at grant for the stock right to avoid discounted-option treatment (Source: 26 CFR § 1.409A-1).

Plain-English definition: DLOM is the discount a valuation analyst applies to reflect the lack of a ready resale market for private-company stock. For you, the key issue is support, not just the final percentage.

A sound 409A report explains the marketability limit, the time horizon and the selected method. The next question is where DLOM enters the valuation process, because timing and share class matter.

Where DLOM Fits in the 409A Valuation Process

DLOM usually comes after the analyst estimates enterprise value, allocates that value across the capital structure and reaches an indicated value for common stock.

The sequence matters because you do not apply DLOM to every value input in the same way. A 409A valuation often starts with an income, market or asset approach to estimate company value. The analyst then considers preferred stock rights, liquidation preferences, conversion features and option pools before reaching a common-stock value. DLOM reduces the relevant common-stock indication to account for illiquidity.

For a startup, the same company may support different DLOM conclusions at different dates. A company 30 days from a signed acquisition agreement usually carries a different marketability risk than a company with uncertain financing prospects and no exit process. Your 409A valuation reports need to reflect those date-specific facts.

A typical analyst file connects DLOM to four practical questions:

●       What security does the valuation measure? Common stock often carries different marketability limits than preferred stock.

●       How long might the holder wait for liquidity? A longer expected hold usually supports a higher DLOM, all else equal.

●       What exit evidence exists? Signed term sheets, board materials and banker updates may affect the holding period.

●       What transfer limits apply? Stockholder agreements and company policies may reduce saleability.

That structure keeps the analysis grounded in your cap table and exit facts. It also sets up the first major method auditors often ask about: restricted stock studies.

Restricted Stock Studies: How the Benchmark Method Works

Restricted stock studies compare restricted shares of public companies with freely traded shares of the same companies, giving analysts market evidence for how investors price limited saleability.

The logic is easy to follow. If a public company sells restricted stock at a discount to its traded stock, the difference reflects the value investors place on marketability, adjusted for facts such as size, risk and restriction period. Analysts use those studies as benchmarks, not as automatic answers.

The IRS DLOM Job Aid reviews restricted stock and pre-IPO studies, among other methods, and cautions reviewers against relying on simple averages without analyzing company-specific facts. The job aid also states it is not an official IRS position and may not be cited as authority, which means you use it as a review framework, not as a rulebook (Source: IRS).

Common benchmark range: Many restricted stock studies show average discounts in the high teens to mid-30% range. For you, that range frames the discussion, but it does not prove your company’s DLOM.

A defensible restricted-stock analysis usually addresses these points in plain terms:

●       Study selection. The report explains why the selected studies fit the valuation date and security.

●       Company risk. Higher operating risk may support more illiquidity cost, while near-term liquidity may support less.

●       Restriction period. The analyst compares the study restriction period with the expected holding period for your shares.

●       Size and volatility. Small, volatile companies often need more explanation because averages hide wide dispersion.

Restricted stock studies work best when the analyst treats them as market evidence and reconciles them with your facts. When the report stops at “study average equals selected DLOM,” the file leaves an auditor an easy challenge.

Protective Put Method: How the Option-Based Method Works

After benchmark evidence, many analysts test DLOM through an option-based model that prices the cost of protecting against a decline during the expected holding period.

The protective put method estimates DLOM by asking what it would cost to buy a put option that protects the stockholder during the period when the share cannot be sold. The higher the volatility, the longer the holding period and the lower the expected liquidity, the more that protection costs. The put cost then informs the marketability discount.

This method gives you a more company-specific way to support DLOM because it uses inputs tied to your facts. It also creates a clear audit trail when the analyst explains each input rather than treating the model as a black box.

The protective put method does not remove judgment. It makes judgment visible. If your company has a credible exit process, the model may use a shorter holding period. If exit timing remains uncertain, the report needs support for a longer assumption.

That is why auditors usually focus less on the model name and more on the inputs. A model with unsupported volatility and holding-period assumptions creates more risk than a simpler method with clear documentation.

Typical DLOM Ranges and What Moves the Discount

Once you understand the main methods, the practical question becomes whether the selected DLOM looks reasonable for the company’s stage, risk and liquidity path.

There is no fixed DLOM for a 409A valuation. In practice, early-stage private companies with uncertain liquidity often support higher discounts than later-stage companies with a credible near-term exit path. The AICPA practice aid on privately held company equity securities issued as compensation discusses marketability as one of the factors analysts consider when valuing private-company equity for compensation purposes (Source: AICPA).

Practical range marker: Many 409A DLOM conclusions fall broadly between 10% and 45%, depending on stage, volatility, transfer limits and expected time to liquidity. A range this broad only helps when the report explains why your facts fit one part of it.

A 12% DLOM may make sense for a late-stage company nearing a transaction. The same discount may look weak for a seed-stage company with no clear exit and high uncertainty. A 40% DLOM may fit a highly illiquid, early-stage security, but it may invite challenge if the company recently completed a strong financing and expects near-term liquidity.

The percentage matters. The explanation matters more. A valuation opinion survives review when it shows the path from facts to method to conclusion.

Documentation That Survives Auditor Review

Auditors and reviewers usually challenge DLOM when the report gives a number without enough evidence behind the holding period, method choice or company-specific adjustments.

Your file should show what the analyst knew at the valuation date. Later events may inform context, but the 409A conclusion depends on information known or knowable at that date. That distinction helps you avoid hindsight and keeps the report aligned with fair market value principles.

A review-ready DLOM workpaper usually includes:

●       Capital structure detail. The cap table, share classes, option pool and liquidation preferences show what common stockholders actually own.

●       Transfer restriction evidence. Stockholder agreements, bylaws and company policies support the lack of ready saleability.

●       Exit-timing support. Board decks, banker updates, financing materials and management forecasts help explain the expected holding period.

●       Method rationale. The report explains why the analyst selected restricted stock studies, a protective put model or both.

●       Input support. Volatility, risk-free rate, restriction period and dividend assumptions connect to market data and company facts.

●       Reconciliation. The final DLOM conclusion explains why one method received more weight than another.

Good documentation does not guarantee a reviewer will accept every assumption. It does give your finance team a clear answer when someone asks, “Why this discount and why now?” That answer matters during audits, fundraising, option grants and board approval.

Common DLOM Mistakes in 409A Valuation Reports

Most DLOM problems come from weak support, not from choosing the wrong method in isolation.

The first mistake is using a generic percentage across valuation dates. If your company raises a major financing round, enters an exit process or changes its transfer policies, the DLOM analysis needs to respond. A repeated number without date-specific analysis may look like a placeholder.

The second mistake is applying a benchmark average without adjustment. Restricted stock study averages span different periods, companies and market conditions. Your report needs to explain why the selected evidence fits your company’s security and liquidity path.

The third mistake is using a protective put model with unsupported inputs. A model output looks precise, but precision does not equal support. If volatility, holding period or dividend yield lacks explanation, the conclusion may still fail review.

The fourth mistake is confusing marketability with control. Lack of control and lack of marketability measure different economic disadvantages. A minority common share may face both issues, but your report needs to separate the concepts so the valuation does not double-count the same risk.

The final mistake is ignoring contradictory evidence. A pending tender offer, investor-led secondary sale or signed exit agreement may reduce marketability risk. If the report leaves that evidence out, the DLOM conclusion may look biased rather than analytical.

Avoiding these mistakes gives your board and finance team a cleaner record. It also makes the next 409A update easier because each assumption has a documented starting point.

How AcumenSphere Supports DLOM Defense in 409A Valuations

A defensible DLOM needs more than a percentage in a valuation schedule, especially when your auditors or investors ask how the number connects to the company’s facts.

AcumenSphere prepares audit-ready 409A valuation reports with a compliance-first approach to fair market value. For DLOM, that means the report explains the security being valued, the expected time to liquidity, the selected valuation method and the evidence supporting each assumption.

When the facts call for benchmark support, we connect restricted stock study evidence to your company’s stage and risk profile. When an option-based method fits better, we explain protective put inputs in plain English so your finance team can answer review questions without translating model jargon. When both methods apply, we reconcile them rather than hiding the judgment behind a single output.

That process helps you grant options with a clearer support file, prepare for auditor questions and keep your cap table decisions aligned with compliance requirements. If your company has a material event, such as a financing, acquisition process or major forecast change, a valuation expert can help you decide whether a new 409A valuation is appropriate.

Conclusion

DLOM in a 409A valuation is a judgment about marketability, supported by evidence. Restricted stock studies give market benchmarks, protective put models test the cost of illiquidity and company-specific documents explain why the selected discount fits the valuation date.

For your team, the strongest DLOM defense answers three questions clearly: what limits marketability, how long the holder may wait for liquidity and why the selected percentage fits the evidence. If the report answers those questions, you have a stronger file for option grants, audits and board review.

If you need a defensible 409A valuation with clear DLOM support, talk to AcumenSphere about an audit-ready FMV report.

Need a Defensible 409A Valuation with Clear DLOM Support?

Whether you're issuing employee stock options, preparing for an audit, raising capital, or navigating a material event, AcumenSphere provides independent, IRS-compliant 409A valuation reports backed by robust market evidence and well-documented assumptions. Our valuation experts help you defend fair market value conclusions with confidence.

Get in touch with our valuation specialists to discuss your 409A valuation requirements.

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