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For privately held business interests, discounts for lack of marketability (DLOM) and discounts for lack of control do more than affect stated value, they can determine whether a wealth tax is calculated on a fair, supportable appraisal or on an inflated estimate that ignores real-world transfer restrictions. In a one-time wealth tax regime, such as the California proposal referenced in current policy discussions, the central valuation issue is whether a private equity interest should be valued as if it were freely tradable and fully controlling, or whether recognized appraisal discounts should reflect the economic reality of owning a minority, nonmarketable stake.

How Wealth Tax Valuation Differs for Private Business Interests

Wealth taxes are typically aimed at taxing net wealth at a point in time, which sounds straightforward until the asset being taxed is a privately held business interest. Unlike public stock, a private business ownership interest does not trade on an open exchange, cannot be sold instantly at a quoted price, and often carries restrictions in the governing agreements. That matters because fair market value, the standard most valuation professionals rely on under IRS Revenue Ruling 59-60, assumes a hypothetical willing buyer and willing seller, neither under compulsion, both with reasonable knowledge of relevant facts.

In practice, that standard is applied through accepted valuation methods such as the income approach, market approach, and, where appropriate, the asset-based approach. If the interest being valued is noncontrolling and illiquid, the appraised value generally should reflect those characteristics. The result is often a DLOM, and in many cases a discount for lack of control as well.

Why DLOM and Lack of Control Matter

A lack of control discount reflects the reduced value of an ownership interest that cannot direct distributions, management, capital allocation, compensation, or sale timing. A lack of marketability discount reflects the cost and delay involved in converting the interest to cash. These are separate concepts, although they are often discussed together because many private business interests are both minority and illiquid.

For a wealth tax, the issue becomes highly visible. If the tax base is defined using a pro rata slice of enterprise value without considering minority status, transfer restrictions, or sale friction, the owner may be taxed on value that no willing buyer would pay. That creates a valuation mismatch. In a privately held manufacturing company, family-owned service platform, or recurring-revenue software business, the difference between enterprise value and the value of a noncontrolling equity stake can be substantial once discounts are supported by the facts.

Where Valuation Discounts Come From

Discounts do not come from thin air. They are derived from the economics of the subject interest and the evidence available in the market. A controlled, marketable equity value may be estimated first, then adjusted for lack of control and lack of marketability to arrive at the value of the actual interest in question.

Discount for Lack of Control

The discount for lack of control is usually most relevant when valuing a minority interest in a closely held corporation, LLC, or partnership. A 10 percent stake in a profitable business may have only limited influence over dividend policy, timing of a sale, cost structure, or buy-sell terms. In valuation work, control premiums from public-company transactions and empirical studies can be reversed to estimate minority discounts, but only when the facts support the comparison. A passive owner in a business with concentrated voting control may justify a meaningful discount, while a class of interests with special governance rights may not.

Discount for Lack of Marketability

DLOM is typically more heavily scrutinized because its size depends on how hard it would be to exit the investment. The more restricted the transfer, the greater the expected discount. Key factors include distribution history, expected holding period, certificate or operating agreement restrictions, size of the anticipated block, dividend capacity, and whether a secondary market would realistically exist. Restricted stock studies, pre-IPO studies, and option-based models are commonly used as evidence, although a qualified appraiser must tailor the analysis to the subject interest rather than mechanically apply a published number.

Valuation Methods That Drive the Tax Base

In a wealth tax context, there is often pressure to simplify. Simplicity, however, can create valuation error. The better approach is to apply standard business valuation methods and then address discounts at the equity-interest level.

For companies with steady cash flow, the discounted cash flow method can be especially useful, particularly where growth, margin expansion, customer retention, or capital needs differ from market averages. A recurring-revenue software company with 110 percent net revenue retention and low churn may merit a higher multiple than a lower-growth business with 80 percent NRR and high customer attrition. But even after a strong enterprise value is developed, a minority holder may still deserve a discount for lack of control and marketability.

Market multiples are also common. EBITDA multiples, SDE multiples for smaller owner-operated businesses, and revenue or ARR multiples for software and recurring-service businesses all begin with enterprise value or controlling interest value indicators. Public-company multiples and precedent transactions can provide support, but they must be normalized for size, growth, concentration, leverage, and control. A mature industrial distributor may trade at a very different EBITDA multiple than a growing SaaS platform, and neither number should be applied without proper context.

For businesses with modest profitability, working capital normalization and owner compensation adjustments can materially affect value. A company that appears to have $1 million of EBITDA may actually have less after adjusting for nonrecurring expenses, excess compensation, or missing maintenance capex. Those same adjustments influence the baseline to which discounts are later applied.

Why Wealth Tax Regimes Are Likely to Challenge Discounts

Tax authorities tend to question discounts when they believe taxpayers are using appraisal concepts to understate wealth. That does not mean the discounts are invalid. It means they must be documented with valuation rigor.

Challenges are most likely in these situations. First, where the ownership interest appears to be in an economically strong business and the taxpayer seeks a large combined discount. Strong earnings do not eliminate discountability, but they can reduce the magnitude of a DLOM if the stake is attractive to buyers or likely to be redeemed. Second, where the entity has transfer provisions that are ambiguous, inconsistent, or newly adopted close to the valuation date. Third, where the appraisal applies generic discount percentages without tying the analysis to the subject company’s cash flow, governance, or expected exit timeline.

Another likely challenge is the use of marketability studies without a clear bridge to the interest being valued. For example, restricted stock studies involve minority interests in public companies, which are not the same as interests in a private LLC with no redemption rights and limited transferability. Those studies can inform analysis, but they are not a substitute for judgment. Likewise, empirical data on private transaction discounts must be reconciled with the company’s size, industry, growth rate, leverage, and buyer universe.

United States Market Context and Valuation Standards

In the United States, private company valuations are shaped by real capital market behavior. Buyers pay higher multiples for businesses with recurring revenue, strong gross margins, diversified customer bases, and low churn. They pay less for customer concentration, cyclical revenue, and key-person risk. These same dynamics matter in wealth tax appraisals because they influence enterprise value before any discount is applied.

Many business owners also think in terms of exit tax treatment. Asset sales often produce a mix of ordinary income and capital gain, while stock sales generally aim for capital gain treatment under federal rules. Section 1202, the QSBS exclusion, can materially affect after-tax proceeds for qualifying C corporations, but QSBS is a tax attribute, not a substitute for proper valuation. It may influence a buyer or seller’s after-tax economics, yet fair market value must still be determined independently.

That distinction is important in a wealth tax setting. The valuation should reflect the interest being taxed, not the owner’s personal tax bracket, estate plan, or liquidity preferences. Still, a hypothetical buyer’s required return will reflect risk, and that is where WACC, growth assumptions, size premiums, and marketability considerations all enter the analysis.

Common Errors Business Owners Should Avoid

One common mistake is assuming that every private business interest automatically receives the same discount. It does not. A 5 percent passive interest in a tightly controlled family enterprise may warrant much stronger discounts than a 45 percent block with meaningful governance rights.

Another mistake is confusing entity-level value with interest-level value. Enterprise value is not the value of every shareholder’s stake. After deducting debt and adjusting for controls, preferred rights, and transfer restrictions, the equity value must be allocated to the correct ownership class.

A third error is omitting support for the discounts altogether. Appraisal discounts should be tied to the agreement terms, operating history, expected holding period, and pricing evidence from comparable market data. A valuation report that merely states a DLOM without explaining its derivation is vulnerable to challenge.

Finally, owners sometimes ignore how thin capitalization, customer concentration, or dependence on a founder can amplify discount risk. If a business cannot operate smoothly without a single person, a buyer generally will not pay the same price as for a well-institutionalized platform. That should be reflected in the valuation before the wealth tax is calculated.

Conclusion

In a one-time wealth tax regime, the treatment of DLOM and lack of control can materially affect the appraised value of privately held business interests. The most defensible valuations are grounded in accepted methodologies, supported by market evidence, and tailored to the actual rights and restrictions attached to the ownership interest. For business owners, the practical takeaway is clear, private company valuations should not rely on simple pro rata assumptions when the economics of the stake tell a different story.

If you own a privately held business interest and want a confidential, well-supported valuation analysis for tax, planning, or dispute purposes, contact InteleK Business Valuations & Advisory for a professional consultation tailored to your situation.