When a business owner or shareholder files for divorce, they may need to value or even sell their interest. Depending on the number and type of shares they own, and the makeup of the business itself, it may be appropriate to consider the application of a marketability discount when valuing their interest. As a general rule, marketability discounts can be appropriate for restricted shares and closely held shares since they can take a longer time to sell and usually have a smaller marketplace. Depending on the specific circumstances, a discount for lack of marketability can then be applied when calculating the fair market value of the shares as part of the valuation process. However, before any discounts are actually applied, the first step in determining if discounts are appropriate is to conduct the valuation.
When conducting a business valuation, an appraiser must determine the fair market value of the business. The fair market value is generally defined as the price that a would be paid between a willing buyer and seller in an arm’s length transaction with reasonable knowledge of relevant facts. To correctly determine the fair market value, the appraiser must consider factors such as:
- The nature of the business and its history from the beginning.
- The economic outlook generally, and specifically for the business’s industry.
- The value of the stock on paper and overall condition of the business.
- The business’s ability to earn.
- The business’s ability to pay dividends.
- The business’s intangible benefits.
- The amount of stock to be valued.
- The market price of stock from other similar businesses that have their stock traded in a free and open market.
- As well as elements of reasonableness and informed judgment.
After arriving at the fair market value, the valuator will then determine whether there should be a discount for lack of marketability. Applying a marketability discount to controlling interests is a controversial practice. Those who refuse to apply it to controlling interests argue that the uncertainty in closely held or restricted stocks is already accounted for in the fair market value when the person looking to sell has a controlling interest. It is much more common to apply a marketability discount to minority interests, as the minority interests can have more hurdles to being sold. Ask your lawyer or appraiser if they think a marketability discount should apply to your shares.