The illiquidity discount is the reduction in value that a stake suffers because it cannot be sold quickly and at a certain price. It does not reflect that the company is worth less, but that the holder cannot convert their position into money when they want. In private companies it usually falls within a broad range depending on the case.
Two identical companies that are not worth the same
Imagine two companies with the same profits, the same sector and the same growth. In one, a shareholder can sell their stake tomorrow at a known price. In the other, selling it requires finding a buyer on their own, negotiating the price without a reference and waiting months. A rational investor does not pay the same for one as for the other, and that difference is the illiquidity discount.
It is important to understand where it comes from: it is not a judgment on the business. The company can be excellent. What is being discounted is the risk and cost of being trapped inside.
What is really being paid for when there is liquidity
Liquidity provides three things that have measurable economic value:
- A reference price: knowing how much the position is worth without having to negotiate it.
- Ability to exit if personal circumstances or your view of the business change.
- Optionality: being able to wait for the right moment instead of selling when the only available buyer appears.
Whoever buys an illiquid stake gives up all three, and demands compensation for it in the form of a lower price.
What determines whether the discount is large or small
The discount is not a fixed figure, and anyone who presents it as such is usually oversimplifying. In practice it varies according to factors such as these:
- The expected exit horizon: the further away and more uncertain it is, the greater the discount.
- The size of the stake: a non-controlling minority is discounted more than a block that gives control.
- What the articles of association and the shareholders' agreement say: restrictions on transfer, pre-emption rights or drag-along and tag-along clauses have a direct impact.
- The existence of natural buyers: if there is an identifiable market of interested parties, the discount falls.
- The quality and frequency of information: a buyer who cannot properly assess what they are buying demands a larger discount.
The cost the founding shareholder assumes without realizing it
This discount is not only a problem for the incoming investor: it is paid by the shareholder who is already inside. It shows up at specific and predictable moments: when they want to bring in a new investor and the valuation offered is lower than expected, when a shareholder wants to exit and there is no orderly way for them to do so, or when a transaction is considered and they discover that the ownership structure makes it difficult.
In other words: illiquidity goes unnoticed while nobody wants to move, and it becomes apparent all at once the day someone wants to.
What reduces the discount in practice
Reducing the discount is not about convincing anyone that the company is worth more, but about removing the frictions that justify it:
- Clear and up-to-date ownership register, so that who owns what is never a matter of dispute. This is the role of the register of shareholders, and disorder in it is a common source of discount.
- Predictable transfer rules: the procedure for selling must be written and executable, not a negotiation from scratch every time.
- Reliable periodic information that allows a third party to assess value without auditing the entire company.
- An orderly path for entry and exit, which is where it makes sense to consider whether the ownership structure should be modernized.
Where tokenization fits, and where it does not
Representing ownership through a tokenized issuance does not create liquidity on its own: there are no buyers simply because the register is digital. What it can do is reduce operational friction, which is a real part of the discount: unequivocal ownership, transfer under a defined procedure, and traceability of who owns what at each moment.
It is worth being honest about the distinction, because it is often poorly communicated: technology can organize the transfer, but demand is still set by the market. If the goal is for current shareholders to be able to sell, the prior question is whether anyone is interested in buying, and no register can resolve that.
Frequently asked questions
What is the illiquidity discount?
It is the reduction in value that a stake suffers because it cannot be sold quickly and at a certain price. It does not reflect that the company is worth less, but that the holder cannot convert their position into money when they want to.
How much is the illiquidity discount?
It is not a fixed figure, and presenting it as such oversimplifies. It varies according to the expected exit horizon, the size of the stake, the transfer restrictions imposed by the articles of association and the shareholders' agreement, and whether there are identifiable natural buyers.
How is the illiquidity discount reduced?
By removing the frictions that justify it: a clear and up-to-date ownership register, predictable and executable transfer rules, reliable periodic information that allows a third party to assess value without auditing the entire company, and an orderly path for entry and exit.
HokenFi is a software and infrastructure provider; it does not provide regulated services (CASP, ESI, EAF, or ERIR). This article is informative and does not constitute financial or legal advice.
