DLOM in Indian Valuations: Chaffe & Finnerty Models
📌 Quick Answer: How is DLOM applied in Indian share valuations?
Discount for Lack of Marketability (DLOM) is a valuation adjustment of typically 15–35% applied to shares of private Indian companies to account for illiquidity. The two most widely accepted quantitative models are the Chaffe protective-put model and the Finnerty average-strike put model. Under IBBI valuation standards, Registered Valuers must document the rationale for DLOM selection. At Virtual Auditor, we apply DLOM using option-pricing frameworks calibrated to Indian market volatility data from NSE/BSE sectoral indices, ensuring defensibility before Income Tax authorities and NCLT.
📖 Definition — Discount for Lack of Marketability (DLOM): A reduction applied to the value of a security to reflect the fact that it cannot be sold quickly on an organised exchange. DLOM captures the economic cost of illiquidity — the time, effort, uncertainty, and transaction costs involved in converting a private-company holding into cash. Recognised under International Valuation Standards (IVS) 2022 and IBBI valuation frameworks.
📖 Definition — Minority Discount (DLOC): A reduction applied to a pro-rata share of enterprise value to reflect the absence of control rights. Also termed Discount for Lack of Control (DLOC). It accounts for the fact that a minority holder cannot unilaterally force dividends, direct strategy, or trigger liquidation. The inverse concept is the Control Premium.
Why Marketability and Control Discounts Matter in Indian Valuations
India’s private company landscape is characterised by concentrated promoter holdings, restrictive articles of association, and limited secondary market infrastructure. Unlike the US, where platforms such as Forge Global or EquityZen provide structured secondary liquidity for pre-IPO shares, Indian private-company shareholders face genuine illiquidity. The Companies Act, 2013 — specifically Section 56(2)(viib) and the associated Rule 11UA of the Income Tax Rules, 1962 — prescribes valuation methodologies (NAV and DCF) for determining fair market value of shares, but is silent on marketability or minority adjustments. This silence creates both an opportunity and a risk for valuers.
Under the IBBI (Registered Valuers) Regulations, 2018, Registered Valuers are expected to follow generally accepted valuation principles. International Valuation Standards (IVS) 105 explicitly recognises DLOM as a legitimate adjustment when valuing interests in private entities. Similarly, the ICAI Valuation Standard 103 on Business Valuation acknowledges that adjustments for marketability and control are part of standard valuation practice.
Situations Where DLOM Is Relevant Under Indian Law
- FEMA share transfers: When pricing shares under the FEMA NDI Rules, 2019, DLOM may be applied to arrive at arm’s-length pricing, particularly in secondary sales between non-residents and residents. RBI requires fair value certification by a SEBI-registered merchant banker or a CA, and the valuer must justify any discounts.
- IBC CIRP valuations: Under Section 35(1)(f) of the Insolvency and Bankruptcy Code, 2016, the resolution professional must obtain valuations from two Registered Valuers. When valuing equity interests in subsidiaries or associates of the corporate debtor, DLOM is frequently applied. See our detailed guide on the valuation paradox.
- ESOP valuations: When valuing employee stock options under Ind AS 102 (Share-Based Payment), the fair value of the underlying shares may incorporate DLOM if the company is unlisted. Our ESOP valuation practice applies DLOM calibrated to the expected time-to-liquidity event.
- SEBI Takeover Code valuations: Under SEBI (SAST) Regulations, 2011, the independent valuer’s report for delisting or open offers must address control premiums and, by implication, the minority discount applicable to public shareholders.
- Family settlements and shareholder disputes: In oppression and mismanagement cases under Sections 241-242 of the Companies Act, 2013, the NCLT regularly encounters arguments about fair value, and DLOM/minority discounts are central to determining equitable relief.
The Chaffe Protective-Put Model for DLOM
The Chaffe model, first proposed by David B.H. Chaffe III in 1993, conceptualises DLOM as the cost of a hypothetical European put option that would provide the holder of a restricted security with downside protection during the restriction period. The economic reasoning is as follows: if the holder could purchase a put option at the current market price, exercisable at the end of the restriction period, then the cost of that put represents the value of marketability — because the put synthetically replicates the ability to sell at a known price.
Black-Scholes Framework Applied to DLOM
The Chaffe model uses the Black-Scholes option pricing model to compute the put option value. The key inputs are:
| Parameter | Description | Typical Indian Range |
|---|---|---|
| Stock Price (S) | Fair value per share before DLOM | As computed by DCF/NAV |
| Strike Price (K) | Set equal to stock price (at-the-money put) | K = S |
| Time to Expiry (T) | Expected restriction period or time to liquidity | 1–5 years |
| Volatility (σ) | Annualised equity volatility | 30–70% for private companies |
| Risk-Free Rate (r) | India 10-year G-sec yield | 6.8–7.2% (March 2026) |
| Dividend Yield (q) | Expected dividend rate | 0–2% for growth-stage companies |
The DLOM under the Chaffe model equals the put option value divided by the stock price, expressed as a percentage. For an at-the-money put with σ = 50%, T = 2 years, r = 7%, and q = 0%, the Black-Scholes put value works out to approximately 18–20% of the stock price — implying a DLOM of 18–20%.
Calibrating Volatility for Indian Private Companies
The most critical and contentious input in the Chaffe model is volatility. Since private companies have no traded price history, the valuer must estimate volatility indirectly. At our practice, we use a three-step approach:
- Select a peer group of listed Indian companies in the same sector using BSE/NSE data. For example, for a private SaaS company, we identify 5-8 listed IT/SaaS companies and compute their historical annualised volatility over 2-3 years using daily returns. See our SaaS valuation guide.
- Apply a Total Beta adjustment using the Damodaran framework. For an undiversified private-company shareholder, the relevant risk measure is Total Beta (= Market Beta / R-squared of the regression). This is typically 2.0–4.0x the levered beta for Indian private companies, leading to significantly higher implied volatility.
- Cross-check against empirical data. Restricted stock studies and pre-IPO transaction data from Indian companies that subsequently listed (such as data from DRHP filings with SEBI) provide a reality check on the implied DLOM.
The Finnerty Average-Strike Put Model
John D. Finnerty published his model in 2012, addressing a well-known criticism of the Chaffe model — that a standard at-the-money put overstates DLOM because a rational holder of a restricted security would optimise the timing of sale within the restriction window, not simply wait until expiry. The Finnerty model replaces the fixed-strike put with a lookback put option with an average strike price, which produces a lower and arguably more realistic DLOM.
How the Finnerty Model Differs
In the Finnerty framework, the holder’s opportunity cost is modelled as the difference between the best price achievable (with full marketability) and the price actually realised (subject to the restriction). The average-strike put captures this by setting the strike price equal to the arithmetic average of the stock price over the restriction period. Because averaging reduces the effective strike relative to the maximum, the put option value — and therefore DLOM — is lower than in the Chaffe model.
Finnerty provides a closed-form approximation based on the Rubinstein (1991) framework for average-price options. The key result is that for a given volatility and time to expiry, the Finnerty DLOM is approximately 50–70% of the Chaffe DLOM. For example, where the Chaffe model yields a DLOM of 25%, the Finnerty model might yield 14–17%.
| Volatility (σ) | Restriction Period | Chaffe DLOM | Finnerty DLOM |
|---|---|---|---|
| 30% | 1 year | 10–12% | 6–8% |
| 40% | 2 years | 18–22% | 11–14% |
| 50% | 2 years | 22–26% | 14–17% |
| 60% | 3 years | 30–36% | 19–23% |
| 70% | 3 years | 35–42% | 22–27% |
Note: Ranges reflect sensitivity to risk-free rate (6.5–7.5%) and dividend yield (0–2%). All figures assume an at-the-money starting position.
Minority Discount (DLOC) in Indian Valuations
While DLOM addresses illiquidity, the Discount for Lack of Control (DLOC) addresses the reduced value of a minority holding that cannot influence corporate decisions. The two discounts are conceptually distinct and must be applied independently.
Quantifying DLOC: The Control Premium Inverse Approach
DLOC is typically derived from observed control premiums in M&A transactions. The relationship is:
DLOC = 1 − [1 / (1 + Control Premium)]
For Indian M&A transactions, control premiums have historically ranged from 20% to 50%, based on data from SEBI open-offer filings and Companies Act scheme arrangements. This translates to DLOC of approximately 17% to 33%. Key data sources include:
- SEBI open-offer data: Under SEBI (SAST) Regulations, 2011, acquirers making open offers must disclose the offer price, which typically includes a control premium over market price. Historical data from 2015–2025 shows median control premiums of approximately 25–35% for Indian listed companies.
- Mergermarket and VCCEdge data: Indian private-company M&A transaction multiples, when compared against comparable listed-company multiples, imply effective control premiums. These must be adjusted for size differences and industry specifics.
- NCLT precedents: In oppression and mismanagement cases, the NCLT and NCLAT have considered arguments about minority discounts. In several cases involving Sections 241-242 of the Companies Act, 2013, tribunals have addressed whether a minority shareholder being bought out should suffer a discount or receive pro-rata enterprise value.
When to Apply DLOC vs. DLOM vs. Both
| Scenario | DLOM? | DLOC? | Rationale |
|---|---|---|---|
| 100% stake in private company | Yes (moderate) | No | Full control; illiquidity remains |
| 5% minority in private company | Yes (high) | Yes | No control + no liquidity |
| 30% stake in listed company | No | Yes (moderate) | Market provides liquidity; limited control |
| 51% controlling stake in private company | Yes | No | Control exists; illiquidity remains |
| ESOP holder, pre-IPO | Yes (high) | Yes | No control + restricted transfer |
Restricted Stock Studies: Empirical Evidence for India
Restricted stock studies form the empirical backbone of DLOM quantification globally. In the US, the SEC’s institutional investor study (1966–1969), the Silber study (1991), the FMV Opinions study (1979–1992), and the Stout Risius Ross studies collectively support DLOM ranges of 15–35% for restricted securities. While no equivalent large-scale Indian restricted stock study exists, several data points are available:
- Pre-IPO placement discounts: SEBI DRHP filings disclose pre-IPO share transactions. The difference between pre-IPO placement prices and subsequent IPO prices effectively captures a composite of DLOM, time-value adjustment, and information asymmetry. Our analysis of 40+ Indian IPOs from 2020–2025 shows pre-IPO discounts of 20–50% relative to IPO price, with a median of approximately 30%.
- Secondary market transactions: Emerging platforms facilitating secondary trades in Indian private company shares (though far less developed than in the US) provide limited but useful data points. Transaction discounts to last-round valuations typically range from 15–40%.
- NCLT/NCLAT orders: Tribunal orders in oppression cases occasionally quantify DLOM or decline to apply it. These provide judicial precedent, though not systematic empirical data.
Regulatory Considerations Across Indian Frameworks
Income Tax — Rule 11UA and Section 56(2)(viib)
Rule 11UA of the Income Tax Rules, 1962 prescribes two methods for valuing unquoted equity shares: the adjusted NAV method and the DCF method. Neither method explicitly addresses DLOM or minority discounts. The CBDT has not issued any circular or notification specifically permitting or prohibiting these adjustments. In practice, Assessing Officers have sometimes challenged DLOM applied within a Rule 11UA valuation, arguing that the prescribed methods are exhaustive. Our position, supported by Tribunal precedents, is that DLOM is a reasonable adjustment within the DCF methodology — particularly since DCF enterprise values inherently reflect a controlling, marketable basis. See our comprehensive Rule 11UA guide.
FEMA — NDI Rules and RBI Pricing Guidelines
Under the FEMA framework, shares issued to non-residents must be at or above fair value, while shares transferred from non-residents to residents must be at or below fair value. DLOM is relevant in the latter case — when a non-resident sells to a resident, applying DLOM to the fair value reduces the ceiling price, potentially facilitating the transaction. RBI Master Direction on Foreign Investment (January 2018, as amended) does not specifically address DLOM but requires arm’s-length pricing. Read our FEMA valuation guide for detailed pricing mechanics.
IBBI and Companies Act Framework
The IBBI (Registered Valuers) Regulations, 2018 require valuers to follow the Companies (Registered Valuers and Valuation) Rules, 2017. Rule 8(3)(j) requires the valuation report to state limitations and caveats. Under Regulation 17, the valuer must exercise due diligence and independent professional judgment. While IBBI has not issued a specific technical standard on DLOM, the framework clearly supports its application where the subject interest warrants it, provided the basis is documented.
Under the Companies Act, 2013, valuations are required for numerous purposes — Section 62(1)(c) (preferential allotment), Section 230 (schemes of arrangement), Section 236 (squeeze-out), and Sections 241-242 (oppression cases). In each case, the question of whether DLOM or minority discount applies depends on the purpose and the level of value being determined.
SEBI Regulations
Under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, and SEBI (SAST) Regulations, 2011, valuations play a critical role in pricing open offers, delisting, and buybacks. SEBI requires independent valuers to certify fairness opinions. In delisting scenarios under SEBI (Delisting of Equity Shares) Regulations, 2021, the reverse book-building mechanism effectively incorporates minority shareholders’ view of the control premium, though DLOM is less relevant for listed securities.
Practical Application: Step-by-Step DLOM Computation
At Virtual Auditor, our standard DLOM engagement involves the following steps:
- Determine the base value: Compute enterprise value using the appropriate methodology — typically DCF for going-concern valuations. See our DCF valuation methodology guide. The enterprise value is then allocated to equity on a controlling, marketable basis.
- Assess the level of value needed: Determine whether the purpose requires a controlling value, minority marketable value, or minority non-marketable value. This depends on the regulatory context and transaction type.
- Select peer-group volatility: Identify 5–10 listed comparable Indian companies and compute their annualised historical volatility using 2–3 years of daily return data from NSE/BSE.
- Estimate restriction period: Assess the expected holding period based on Articles of Association restrictions, shareholder agreement lock-ups, and realistic exit timeline (IPO, secondary sale, or strategic acquisition).
- Run both Chaffe and Finnerty models: Compute DLOM under both models using the Black-Scholes framework (Chaffe) and the Finnerty closed-form approximation. Present results as a range.
- Cross-validate with empirical data: Compare model output against restricted stock study benchmarks and pre-IPO discount data from Indian DRHP filings.
- Select and document the DLOM: Choose a DLOM within the computed range, supported by qualitative factors (company size, transfer restrictions, dividend history, information asymmetry). Document the rationale in the IBBI-format valuation report.
Qualitative Factors Affecting DLOM Magnitude
Beyond the quantitative models, several company-specific factors influence where within the DLOM range the selected discount should fall:
- Transfer restrictions in Articles of Association: Restrictive pre-emption rights, board approval requirements, and right of first refusal clauses increase DLOM. Most Indian private companies have such restrictions under Section 2(68) of the Companies Act, 2013.
- Dividend policy and distributions: Companies that regularly pay dividends provide interim liquidity, reducing the effective DLOM. Growth-stage companies with zero dividends attract higher DLOM.
- Size and revenue stage: Smaller companies with revenues below INR 50 crore typically attract DLOM at the higher end of the range (25–35%). Larger, established companies with revenues above INR 500 crore may warrant DLOM of 15–20%.
- Prospect of an IPO or exit: Companies with a near-term IPO plan (within 12–18 months) have significantly reduced DLOM, as the restriction period is short. Companies with no foreseeable exit path attract higher DLOM.
- Information availability: Companies with audited financials, independent board members, and regular reporting to shareholders have lower information asymmetry, supporting a lower DLOM.
- Put options or tag-along rights: Existing contractual provisions that provide exit mechanisms reduce DLOM. This is common in PE/VC-backed companies with shareholder agreements that include put options after a specified holding period.
🔍 Practitioner Insight — CA V. Viswanathan
In our practice at Virtual Auditor (IBBI/RV/03/2019/12333), we have applied DLOM in over 100 valuation engagements across FEMA compliance, IBC resolution, ESOP fair valuation, and Income Tax proceedings. The most common mistake we see in peer reports is applying a blanket 25% DLOM without model support — this is increasingly challenged by Assessing Officers and Tribunal members who expect quantitative rigour. We always run both Chaffe and Finnerty models, present the range, and select a point estimate supported by qualitative factors. For Indian private companies in the INR 10–100 crore revenue range, our typical DLOM falls between 18–28%, depending on the restriction period and volatility profile. The Finnerty model generally produces more defensible results because it accounts for optimal trading behaviour, which is the standard courts and regulators implicitly assume. Our business valuation engagements typically start at INR 50,000 for standalone DLOM analysis as part of a comprehensive valuation report.
Stacking DLOM and Minority Discount: Multiplicative Application
When both DLOM and DLOC apply (e.g., a 5% minority interest in a private company), they must be applied multiplicatively — not additively. The combined discount formula is:
Combined Discount = 1 − [(1 − DLOC) × (1 − DLOM)]
Example: DLOC = 20%, DLOM = 25%
Combined = 1 − (0.80 × 0.75) = 1 − 0.60 = 40%
Additive stacking (20% + 25% = 45%) overstates the discount because it applies the DLOM to the full enterprise value rather than the already-discounted minority value. This is a common error we see in Indian valuation reports, and one that is increasingly scrutinised by NCLT benches and Income Tax Appellate Tribunals. For convertible instruments, the analysis becomes more complex as optionality affects both DLOC and DLOM.
Common Errors in Indian DLOM Practice
- Using US volatility for Indian companies: Indian equity markets exhibit significantly higher volatility than US markets. Using Damodaran’s US Total Beta or implied volatility without adjusting for Indian market conditions understates DLOM.
- Ignoring the restriction period: Applying DLOM without specifying the expected holding period renders the model unanchored. The restriction period must be estimated based on legal and practical constraints.
- Double-counting illiquidity: If the DCF model already uses a higher WACC to account for illiquidity (via a specific risk premium or company-size premium), applying full DLOM on top creates double-counting. The valuer must ensure consistency between the discount rate and the DLOM.
- Applying DLOM to NAV-method valuations without justification: Under Rule 11UA’s NAV method, the fair value is asset-based. Applying DLOM to an NAV figure requires careful justification since NAV already reflects book values, not market-based enterprise value.
- Failing to consider put options in shareholder agreements: Many PE/VC-backed Indian companies have contractual put options or drag-along rights that effectively provide liquidity. Ignoring these provisions overstates DLOM.
📋 Key Takeaways
- DLOM in Indian private company valuations typically ranges from 15–35%, quantified using Chaffe (protective put) or Finnerty (average-strike put) option-pricing models.
- DLOC (minority discount) is derived from observed control premiums in Indian M&A transactions, typically 17–33%.
- DLOM and DLOC are applied multiplicatively, not additively — stacking them additively overstates the combined discount.
- Indian regulators (IBBI, CBDT, SEBI) do not prescribe a specific DLOM model, but documentation and quantitative rigour are essential for defensibility.
- Volatility calibration must use Indian peer-group data from NSE/BSE, adjusted for Total Beta where the shareholder is undiversified.
- The Finnerty model generally produces lower and more defensible DLOM estimates than the Chaffe model due to its average-strike construct.
- Qualitative factors — transfer restrictions, dividend policy, IPO prospects, and company size — should inform where within the model range the selected DLOM falls.
- Avoid double-counting illiquidity if the discount rate (WACC) already incorporates a company-specific risk premium for illiquidity.
Frequently Asked Questions
What is DLOM in Indian valuations?
DLOM (Discount for Lack of Marketability) is a valuation adjustment applied to shares of private companies in India to reflect the inability of shareholders to sell their holdings quickly at fair value on an organised exchange. Under IBBI valuation standards and commonly accepted valuation practice, DLOM typically ranges from 15% to 35% for Indian private companies, depending on volatility, restriction period, and company-specific qualitative factors.
What is the difference between DLOM and minority discount?
DLOM reflects the reduced value due to illiquidity — the inability to convert the shareholding to cash quickly. Minority discount (DLOC) reflects the reduced value due to absence of control — the inability to influence company decisions such as dividends, management appointments, or strategic direction. They are conceptually distinct and are applied as separate, multiplicative adjustments.
Which DLOM model is preferred by Indian regulators?
Indian regulators including IBBI, CBDT, and SEBI do not mandate a specific DLOM model. IBBI Registered Valuers commonly use the Chaffe protective-put model or the Finnerty average-strike put model. The key regulatory requirement is that the methodology be reasonable, quantitatively supported, and thoroughly documented in the valuation report.
Is DLOM applicable under Rule 11UA for Income Tax?
Rule 11UA prescribes NAV and DCF methods for share valuation but does not explicitly address DLOM. The CBDT has neither permitted nor prohibited DLOM within Rule 11UA computations. In practice, DLOM is more defensible when applied within a comprehensive IBBI-standard valuation report rather than a bare Rule 11UA computation. The Income Tax Department may challenge aggressive DLOM, so robust documentation is essential.
What DLOM range is typical for Indian private companies?
For Indian private companies, DLOM typically falls within 15–35%. Companies with severe transfer restrictions (restrictive AoA, board approval for transfers), smaller size (revenue below INR 50 crore), weaker financials, and no near-term IPO or exit path attract DLOM at the higher end. Companies with contractual put options, tag-along rights, established secondary market activity, or near-term listing plans may have DLOM as low as 10–15%. Our valuation practice determines the specific DLOM based on both quantitative model output and qualitative assessment.
Can DLOM and minority discount be applied together?
Yes. When both conditions exist — the subject interest is a minority stake in an illiquid private company — both DLOM and DLOC are applied. They must be applied multiplicatively: Combined Discount = 1 − [(1 − DLOC) × (1 − DLOM)]. For example, a 20% DLOC and 25% DLOM yield a combined discount of 40%, not 45%.
How does DLOM affect ESOP valuations in India?
For ESOP valuations under Ind AS 102, the fair value of the underlying shares may incorporate DLOM if the company is unlisted. The DLOM reflects the employee’s inability to sell the shares during the vesting period and any post-vesting lock-up. The restriction period for DLOM is calibrated to the expected time from grant to the first realistic liquidity event (IPO, acquisition, or secondary sale). See our ESOP valuation guide.
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