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THERE IS NO THEORETICAL OR LEGAL REASON WHY DLOMS CANNOT OR SHOULD NOT BE APPLIED TO CONTROLLING INTERESTS.
discounts
for lack of marketability (DLOMs) can have a significant impact on a final determination of value of a business ownership interest When these discounts apply, they provide a reduction in value that can vary from a small percentage to more than 50%. Evidence clearly establishes that DLOMs exist and apply to minority interests, and many ways of quantifying the discount have been developed. With controlling interests, however, some have argued that DLOMs should not apply. This article will address this issue by examining the definition and theoretical basis, tax law, evidence, and computational methodologies applicable to controlling interests.
Arguments Against DLOMs for Controlling Interests
Arguments have been advanced that a DLOM should not be applied to a controlling shareholder.1 The principal argument asserts:
1 . Value is the result of the present value of future cash flows.
2. Controlling owners have control of the cash flows.
3. It is not logical to discount a value for marketability when the owner has control over the source of the value.
This argument is not convincing, however, because it does not consider what actually occurs with regard to the receipt of cash by a controlling owner. Namely, even if an owner decides to sell a business, the cash payment is uncertain and may not be received for some time. Thus, the owner does not have actual control over the amount eventually received nor the timing of receipt. This situation is significantly different from one involving the sale of a marketable interest in a freely traded stock.
Another argument against controlling interest DLOMs states that no discount should be applied because an owner can receive cash flow while the business is for sale. A comparison of cash flows for an immediate sale versus a future sale defeats this argument:
* If a business is sold immediately, the seller receives an immediate lump sum payment, followed by a series of future cash flows derived from the investment of the lump sum. (The investment vehicle would be one of the seller's choosing as to risk and return.)
* In contrast, a sale at some future date provides a series of...