Illiquidity Discount

An illiquidity discount is a price reduction for shares that cannot be sold quickly. Because the owner cannot turn the investment into cash at any time, such a stake is worth less. The discount compensates for this disadvantage in the valuation. The reason is economically clear: a listed share can be sold within seconds at a known price, while selling a stake in an unlisted company takes months, involves substantial cost, requires a buyer and is uncertain in outcome.

Most affected are holdings in mid-sized companies, minority stakes without tag-along rights, and shares whose transferability is restricted by consent requirements or pre-emption rights. The size of the discount is debated in the valuation literature across a wide range and derived from various empirical approaches, such as comparing prices for restricted and freely tradable shares. There is no generally accepted figure, so any discount applied must be justified. Methodologically the same fact can be captured in two ways, either as a discount on the value determined or as a premium on the cost of equity. Applying both at once would be double counting. The discount for lack of marketability should be distinguished from the minority discount, which reflects the absence of control. Both can exist side by side and are frequently conflated in practice.

It should be noted in practice that the discount is not a fixed figure but depends on the specific circumstances: the size of the stake, the existence of contractual exit rights, the number of potential buyers and whether distributions are being made. A holding with a reliable dividend and a put right is considerably less illiquid than one with neither. Those circumstances must be set out in the reasoning, because blanket discounts are regularly rejected in court proceedings.