Valuation Discounts on Pre-IPO Shares in an Estate: DLOC and DLOM

A founder gifts 100,000 shares of her Series C-stage company to an irrevocable trust. The most recent preferred round priced at $12 per share on a $400 million post-money. Pro-rata, her 100,000 common shares are worth $1.2 million at the preferred price.

Her appraiser, following standard valuation methodology, applies a 20% discount for lack of control (common doesn’t have the rights of preferred) and a 25% discount for lack of marketability (the shares can’t be sold freely). Combined: 40% discount. The shares are valued at $720,000 for gift tax purposes.

The gift uses $720K of her lifetime exemption instead of $1.2M. On a $12M gift program, appropriate discounts can save her $2-3M of exemption that can be used for additional transfers.

For founders planning estate transfers of pre-IPO stock, understanding and properly documenting valuation discounts is central to the planning. Discounts are defensible, widely recognized, and often the biggest lever in pre-IPO wealth transfer.

What the discounts are

DLOC (Discount for Lack of Control). A minority interest in a company does not control the company’s decisions. A control buyer would pay more per share than a minority buyer. The discount reflects the difference.

For privately held common stock in a venture-backed company:

• Minority holder has limited voting rights.
• Cannot force distributions, transactions, or strategic changes.
• Subject to decisions of majority (often preferred) holders.
• Lack of control is real and measurable.

Typical DLOC range: 15-25% for common stock of VC-backed companies where preferred holds control.

DLOM (Discount for Lack of Marketability). The inability to sell shares quickly, privately, or at a known price. Public market shareholders can sell any day; private shareholders cannot.

Typical DLOM range: 15-35% for common stock of private venture-backed companies. Higher for very early stage, lower for late-stage companies with known liquidity horizon.

How discounts are combined

Discounts are multiplicative, not additive:

• 20% DLOC means value is (1 - 0.20) = 80% of undiscounted.
• 25% DLOM applied to the already-discounted value: (1 - 0.25) × 80% = 60%.
• Combined discount: 40%.

Both discounts apply to common stock in most contexts. They measure different things and are independently justified.

The source of the values

Pre-IPO stock is typically valued in three contexts:

1. Preferred round price. Lead investor’s price per preferred share in the most recent priced round. Includes a control premium and preferred rights; not the right number for common.

2. 409A valuation. Independent appraisal of common stock for employee stock option pricing. Already includes significant discounts (often 60-80% below preferred price). Can serve as a starting point for gift and estate valuations but often should be refreshed and specifically validated for the transfer purpose.

3. Qualified appraisal for transfer. Specific appraisal for the gift or estate event. Considers the round price, 409A, company financials, market comparables, and applies DLOC and DLOM specifically for the transfer purpose.

The qualified appraisal

For gifts of private company stock over $5,000 (per category), a qualified appraisal under Treas. Reg. §1.170A-17 is required. The appraisal must:

• Be prepared by a “qualified appraiser” with expertise and credentials (typically ASA, CVA, or similar designations plus business valuation experience).
• Include specific items: description of property, date of valuation, valuation methodology, appraiser’s qualifications, statement of good faith, statement of IRS-required elements.
• Be dated within 60 days of the transfer.

For estate tax, Form 706 requires a similar qualified appraisal for illiquid property.

The appraiser’s methodology should explicitly address DLOC and DLOM:

• Compare to guideline public companies.
• Use studies (Mergerstat, Pratt’s Stats, Partnership Profiles) for discount benchmarks.
• Apply professional judgment to the specific facts.
• Document supporting data.

IRS challenges to discounts

The IRS can challenge discounts if:

• Appraiser’s methodology is deficient.
• Discounts exceed defensible ranges.
• Facts support lower discounts (e.g., imminent IPO reduces DLOM argument).
• Documentation is insufficient.

Common IRS challenge areas:

• DLOM above 35% on late-stage private companies.
• DLOC above 25% on founder-held common.
• Aggregate discounts above 40-45% on standard common.

Taxpayers often achieve 25-40% discounts on common stock in ongoing venture-backed companies; higher discounts require specific facts.

Tax Court litigation has generally upheld discounts in the 15-35% range for each component with good appraisal support.

Factors affecting DLOM

• Time to liquidity. Closer to expected IPO or M&A = lower DLOM. A company with a signed IPO filing has meaningfully lower DLOM than a Series B company.
• Restrictions on transfer. Rights of first refusal, transfer restrictions, lockups = higher DLOM.
• Dividend payments. Dividend-paying stock has lower DLOM (intermediate liquidity via dividends).
• Secondary market activity. Presence of secondary transactions (tender offers, secondary sales) lowers DLOM.
• Company size and stage. Larger, later-stage companies = lower DLOM.

Factors affecting DLOC

• Voting rights. More voting rights = lower DLOC. Non-voting common has higher DLOC.
• Preferred overhang. More senior preferred = higher DLOC on common.
• Distribution rights. Preferred’s right to force distributions affects common.
• Board composition. Minority board representation can reduce DLOC slightly.
• Protective provisions. Preferred veto rights increase DLOC on common.

Timing: the IPO effect

Discounts compress as IPO approaches. An S-1 filed company has near-public liquidity; DLOM may be 5-10% rather than 20-30%.

Strategic planning: fund GRATs, SLATs, IDGTs well before IPO to lock in higher discounts. Post-S-1, the valuation reflects the imminent public market price with smaller discounts.

Examples:

• Funding 18 months pre-IPO: typical 40% combined discount.
• Funding 12 months pre-IPO: typical 30-35% combined discount.
• Funding 6 months pre-IPO: typical 20-25% combined discount (if S-1 filed).
• Funding post-S-1 but pre-pricing: typical 10-15% combined discount.
• Funding post-IPO during lockup: typical 10-20% combined discount (Rule 144 related).

The earlier the transfer, the larger the discount. Combined with appreciation between now and IPO, transfers 12-18 months before IPO dramatically multiply the pre-sunset exemption value.

Comparison: typical discounts by stage

Company stage	Typical DLOC	Typical DLOM	Combined
Early seed/Series A	15-25%	25-40%	35-55%
Series B-C	15-25%	20-35%	30-45%
Series D+ (late stage)	15-20%	15-30%	25-40%
Pre-IPO (S-1 filed)	10-20%	10-20%	20-30%
Post-IPO, pre-lockup-end	0%	10-20%	10-20%
Post-lockup public	0%	0-5%	0-5%

Layering with gifting strategies

Valuation discounts apply to all gift and estate transfers of pre-IPO stock:

• SLATs: use discounts to transfer more exemption.
• GRATs: use discounts at funding to set up beneficial zeroed-out economics.
• IDGT installment sales: sale price reflects discounts.
• Dynasty trusts: funding value reflects discounts.
• Charitable gifts (CRT, CLT, DAF): appraised value for deduction purposes reflects discounts.

For a founder gifting $5M of pre-IPO stock with 40% combined discount, the “real” economic value transferred (without discount) is $8.3M. Using $5M of exemption to transfer $8.3M of value is a 67% exemption leverage ratio.

Documentation best practices

1. Engage a credentialed appraiser early (not last-minute).
2. Provide complete financial and capitalization documents.
3. Have counsel review appraisal methodology and conclusions before relying on them.
4. Retain the qualified appraisal for IRS review if challenged.
5. Consider second opinions for large gifts.
6. Document board actions, transfer paperwork, and consideration if any.

Frequently asked

Are discounts available on post-IPO restricted stock? Yes, but much smaller. Rule 144 restrictions on insider/restricted stock warrant some DLOM; typical 10-20% for restricted post-IPO common.

Can I apply discounts to preferred stock? Yes. Preferred can have DLOC if the holder doesn’t control the company, and DLOM if subject to transfer restrictions. Typically smaller discounts than common.

What if my company has an imminent secondary tender? A known liquidity event near-term reduces DLOM. Discount appraisers consider tender activity and company-disclosed plans.

Can I use the same appraisal for multiple gifts? Only for gifts within the 60-day window of the appraisal date. Gifts made later require refreshed appraisals.

What if the IRS challenges my discounts years later? The IRS has the burden of proving the discounts were unreasonable if your appraisal meets qualified appraisal standards. Burden shifts to the taxpayer if documentation is deficient.

Next step

If you are planning estate transfers of pre-IPO stock, engage a qualified appraiser 60-90 days before target transfer date. Discuss discount methodology and support. Coordinate with estate counsel to ensure valuation aligns with transfer structures (SLAT, IDGT, GRAT, etc.). Keep all documentation for future IRS inquiry.