Understanding Marketability and Size Discounts: Why Your Business Isn't Worth Public Company Multiples

A $3M revenue plumbing company and a $3B revenue public company are in the same industry. They produce the same kind of services. On a static snapshot they look similar — revenue per employee, gross margins, labor mix, supplier base. And yet the public company trades at 12x EBITDA and the plumbing company sells at 4x. The eight-turn gap is not a mispricing. It is the sum of two specific, quantifiable adjustments that the professional valuation literature has been measuring for more than thirty years: the size premium and the discount for lack of marketability.

Understanding what those adjustments are, where they come from, and how they flow into the final concluded value is the difference between a valuation that holds up in negotiation and a valuation that evaporates on contact with a real buyer.

The size premium: why smaller companies require higher returns

Size premium is an adjustment to the cost of equity. The logic is that smaller companies are riskier in ways that do not show up in beta alone. They have less access to capital markets, less management depth, less customer diversification, less product diversification, and they are more sensitive to business cycles. Investors require a higher expected return to hold the equity of a small company than to hold the equity of a large company with otherwise similar characteristics.

Kroll publishes the Cost of Capital Navigator (formerly the Duff & Phelps Risk Premium Report), which breaks down historical returns by size decile of the public market universe. The data goes back decades. The pattern is consistent: the smallest decile of public companies has historically produced equity returns roughly 5 to 7 percentage points higher than the largest decile, and the relationship is monotonic — smaller always means higher required return.

Below the public market universe entirely, the size effect is even larger. Professional valuators applying the Kroll data to private businesses use the smallest decile as a floor and often add further adjustments for companies below that threshold. A $3M revenue plumbing company is typically two orders of magnitude smaller than the smallest public company in the Kroll dataset, and the size premium applied to its cost of equity can run 6% to 8% above the large-company baseline.

What does that mean in dollars? On a company with $400K of normalized earnings, a 400 basis point increase in the discount rate can drop the concluded value by 20% to 25%. The size premium is not a footnote — it is often the single largest downward adjustment in the valuation.

The discount for lack of marketability

DLOM is a separate adjustment for a separate problem: private companies cannot be sold as quickly or as cleanly as public companies. A public-company shareholder can sell 10,000 shares at market in thirty seconds. A private-company owner takes six to twelve months to market and close a sale, pays 8% to 12% in transaction costs, and accepts the specific buyer willing to transact — not the most optimistic price in a liquid market.

Three main data sources are used to quantify DLOM.

Restricted stock studies compare the price of restricted public-company shares (shares that cannot be sold for a defined period due to SEC Rule 144) against the price of freely-tradable shares in the same company. The observed discount on restricted shares — typically 25% to 35% — is used as a proxy for the value of liquidity itself.

Pre-IPO studies compare private-company transactions against the same company's subsequent IPO price, with the discount representing the value of going from illiquid to liquid. These studies also cluster around 25% to 35%, though the range can be wider.

Option pricing models (Longstaff, Finnerty, Chaffe) build theoretical DLOMs based on the volatility of the underlying business and the expected holding period. These models produce DLOMs that scale with business-specific risk and time to liquidity, which is useful for customized application.

The Pepperdine Private Capital Markets Project surveys intermediaries on actual DLOM application annually. The survey results support a typical DLOM range of 20% to 35% for lower and middle-market private businesses, with higher discounts for smaller, riskier, or harder-to-sell businesses and lower discounts for businesses with robust buyer pools or identifiable liquidity events.

How the two discounts interact

Size premium affects the discount rate, which affects the indicated value from the income approach. DLOM is applied after the indicated value has been calculated, as a separate adjustment. Both reduce the concluded value, but they do so at different points in the calculation, and they are independent of each other — applying one does not remove the need for the other.

A typical small-business valuation workflow looks like this:

1. Build the discount rate: risk-free rate + equity risk premium + size premium + industry beta adjustment + company-specific risk
2. Apply the discount rate to projected or capitalized earnings to produce an income-approach value
3. Cross-check against comparable private transactions (market approach)
4. Reconcile and weight the approaches to produce an indicated value on a marketable basis
5. Apply DLOM to the indicated value to produce the final concluded value on a non-marketable basis

Both discounts are required because they address different things. Size premium reflects the return an investor would demand to hold the equity. DLOM reflects the liquidity of that equity interest. You need both because a high-return, illiquid asset is worth less than a high-return, liquid asset of identical earnings, and a high-return, small asset is worth less than a high-return, large asset of identical earnings.

The math on a real example

A services business with $600K of normalized EBITDA, stable, 8% annual growth, private, owner-operated.

Step 1 — Discount rate build:

• Risk-free rate (10-year Treasury): 4.2%
• Equity risk premium: 5.5%
• Size premium (microcap decile, below the Kroll smallest category): 6.2%
• Company-specific risk premium: 2.0%
• Total required equity return: 17.9%
• Less expected long-term growth: 3.5%
• Capitalization rate: 14.4%

Step 2 — Income approach indicated value: $600K / 0.144 = $4.17M

Step 3 — Market approach indicated value (4.0x EBITDA from comparable private deals, already reflects the private-market context): $2.40M

Step 4 — Reconciliation: Weight 50% income, 50% market, producing a blended marketable-basis value of ~$3.28M.

Step 5 — DLOM adjustment (25%): $3.28M × (1 – 0.25) = $2.46M concluded value

Without the size premium, the income approach would have produced ~$6.0M instead of $4.17M. Without DLOM, the concluded value would be ~$3.28M instead of $2.46M. The two discounts together account for roughly $3.5M of downward adjustment against a "pure" large-company multiple approach. That is why this business sells at 4x EBITDA and not 12x.

Where calculators and brokers get it wrong

Calculators ignore both discounts entirely and produce values that are too high. Brokers sometimes compensate by applying a single "private-company multiple" drawn from industry gossip, which handles part of the gap but not all of it and not in a transparent way. The difference is the audit trail: a professional valuation shows the size premium, the cap rate build, the comparable transaction set, and the DLOM calculation separately, so the reader can evaluate each component independently.

This matters in negotiation. A buyer who sees a number without the work cannot verify it and usually discounts the number further for the uncertainty. A buyer who sees the full build can verify, agree or disagree with specific components, and negotiate on defensible grounds. In practice, valuations with full documentation close at prices 5% to 12% above comparable valuations with opaque methodology, because the documented number is defensible and the opaque number is not.

How VEMLogic applies the discounts

VEMLogic Professional reports present the full discount-rate build with Kroll size premium data cited explicitly and cross-checked against Damodaran industry data. DLOM is calculated using the Pepperdine survey ranges with adjustment for business-specific factors (size, liquidity profile, customer concentration). Both adjustments are shown in the report as separate line items with their reasoning attached, not buried in a single blended multiple. For owners, buyers, and advisors who need to understand not just the number but how it was built, this is the level of disclosure that makes the conclusion defensible.