The 9 Mandelbaum Factors for Marketability Discounts

The Mandelbaum factors are a framework from the 1995 U.S. Tax Court case Mandelbaum v. Commissioner used to help quantify a marketability discount for interests in closely held companies. The factors guide an appraiser in assessing how much the value of a private ownership interest should be reduced to account for its lack of ready marketability. This analysis is a common element in valuations for gift and estate tax purposes. The framework considers specific attributes of both the company and the shares.

The Concept of Marketability Discounts

A Discount for Lack of Marketability (DLOM) addresses the reality that an ownership interest in a private company is less valuable than a comparable stake in a public one. The core reason is liquidity—the ability to convert an asset into cash quickly. An owner of shares in a publicly traded company can sell them almost instantly on a stock exchange.

Selling an interest in a private, closely held business is a far more complicated and lengthy endeavor, as there is no established marketplace. This effort involves significant time and negotiation, so the DLOM is a percentage reduction applied to the value of the private interest to compensate for this lack of liquidity.

For a buyer, the discount accounts for the risk assumed when purchasing an asset that cannot be readily converted to cash. Valuation professionals analyze various factors to determine an appropriate DLOM. For instance, a stake in a mature, profitable private company is more marketable than one in an early-stage venture.

Analysis of Company-Specific Attributes

The company’s financial statement analysis

An analysis of a company’s financial statements provides a foundation for the marketability discount by reviewing historical performance, including revenue, profitability, and cash flow. If a company’s operating results and financial position have been consistently strong compared to its peers, a lower discount may be warranted. A company with a robust balance sheet, low debt, and sufficient cash is viewed as more stable and a more attractive investment. Conversely, a history of poor performance or a weak balance sheet could justify a higher discount, as these issues increase risk for a potential buyer.

The company’s dividend policy and history

A company’s policy and history regarding shareholder distributions measure its ability to provide a return to investors without them selling their shares. A consistent history of paying dividends can reduce the marketability discount by providing liquidity to shareholders. This offers a tangible cash return, making the illiquid nature of the shares more palatable. A company that has the financial capacity to pay dividends but chooses not to, or has an inconsistent payment history, may warrant a higher discount because an investor’s only return is through an eventual sale.

The nature of the company, its history, industry position, and economic outlook

The specific nature of the business, its maturity, and its standing within its industry are important considerations. A well-established company with a strong brand, a dominant market position, and a positive economic outlook is generally considered more marketable. Such a company is often seen as a more stable and predictable investment, making it easier to attract buyers and leading to a lower discount. Conversely, a company in a declining industry or with a volatile operating history presents a higher risk, supporting a higher marketability discount.

The quality and depth of the company’s management

The strength and experience of the management team are linked to the company’s perceived value and marketability. A proven management team with a track record of success and strategic vision provides confidence to potential investors, which can make an ownership interest more attractive and argue for a lower discount. A company that is highly dependent on a single key person, or has a management team that is perceived as weak, presents a significant risk. This “key person” risk makes the investment less secure and harder to market, justifying a higher discount.

The company’s redemption policy

A company’s stock redemption policy can have a direct impact on the liquidity of its shares. If the company has a history of redeeming shares from its owners, or if a formal policy provides this option, it can create a limited form of marketability. This right to have shares purchased by the company provides a potential exit path for a shareholder. The existence of such a policy can reduce the marketability discount, while the absence of one reinforces the illiquid nature of the investment and supports a higher discount.

Analysis of Share-Specific Attributes

The amount of control in the transferred shares

The level of control associated with the block of shares being valued is a factor. A controlling interest, which gives the owner the power to direct the company’s policies and strategic decisions, is inherently more marketable than a non-controlling, minority interest. The ability to influence dividend payments or the timing of a company sale makes the investment more valuable. A minority interest lacks these powers and is subject to the decisions of controlling shareholders, which warrants a higher discount.

Any restrictions on the transferability of the interest

Restrictions on the ability to transfer shares are a direct impediment to marketability and are often found in a company’s bylaws or shareholder agreements. They may include rights of first refusal that require the selling shareholder to first offer the shares to the company or other existing shareholders. Such restrictions limit the pool of potential buyers and can complicate the sale process. The more stringent the restrictions, the less marketable the shares become, justifying a higher marketability discount.

The expected holding period for the shares

The anticipated length of time an investor must hold the shares before a liquidity event, such as a sale of the company or an IPO, is a consideration. A longer expected holding period increases the risk for an investor, as capital remains tied up and exposed to business risks for a greater duration. An investment that is expected to become liquid in the near term is more attractive and thus more marketable, suggesting a lower discount. If there is no clear path to liquidity, an investor must be prepared to hold the shares indefinitely, justifying a higher discount.

The costs associated with a potential public offering

The potential costs of creating a public market for the shares through an IPO are also considered. These costs can be substantial, including legal, accounting, and underwriting fees, and can detract from the investment’s value. The analysis considers the likelihood that the buyer of the interest would have to shoulder these registration and offering expenses. If the buyer is expected to bear the full cost, a higher marketability discount may be warranted.

Determining the Final Discount

The process of arriving at a final marketability discount is not a simple mathematical exercise but involves a comprehensive and subjective weighing of all nine Mandelbaum factors. A valuation professional must exercise professional judgment, considering the unique facts and circumstances of the specific company and the ownership interest being valued. There is no formula that dictates how much weight each factor should receive.

The appraiser synthesizes the analysis of the company-specific and share-specific attributes into a single, defensible conclusion. For example, a strong dividend history suggesting a lower discount might be offset by significant transfer restrictions suggesting a higher discount. This synthesis is documented in a formal valuation report, which explains the rationale for the selected discount percentage. The final DLOM is then applied to the base value of the ownership interest to determine its fair market value.