If a shareholder is selling a minority share (meaning a less-than-controlling interest) in a privately-held business, a minority discount may be applied to the pro-rata share value. There are a number of factors that are considered by business valuators to determine this discount. In this post, we look at 8 factors quantifying minority discounts. But first…
What is a Minority Discount and Why Is It Applied?
A minority discount represents an amount or percentage deducted from the Pro Rata share of value (meaning its proportionate value as related to the whole) to reflect the absence of some or all of the powers of control, and that the investment may be somewhat illiquid and/or less marketable than a controlling interest.
The main reason for the discount is that a minority shareholder does not usually have the ability to make management decisions such as the determination of management compensation and bonuses, amendment of articles of incorporation and by-laws, acquisition and liquidation of assets, dividend policy, sale of the company, election of the majority of the Board of Directors, etc.
The 8 Factors
There is no mathematical formula to quantify the discount for lack of control. Rather, it is determined based on a number of considerations, including the following:
1. The size of the shareholding compared to other shareholders
Generally speaking, the greater the size of the minority shareholding, the lower the discount.
2. The relationship between the shareholders
The relationships between shareholders can affect the extent of the minority discount. For example, if the company is controlled by a group of minority shareholders who act in concert in voting matters, it may be argued that there should be no minority discount applied to the value of the shares of a member of that group if the group collectively controls the corporation.
3. Impact of provisions of the shareholders’ agreement
If there are provisions in the shareholders’ agreement that provide for liquidity of a minority interest (such as the option to sell the shares to existing shareholders or back to the company), the discount is reduced, all else equal.
4. Provisions in the articles of incorporation and statutory rights providing protection to the minority interest
These protections represent reduced risk, and therefore reduce the discount.
5. Discounts implicit in prior sales of shares in the corporation.
Prior sales can set precedents as to the appropriate discount for minority shares.
6. Past history of dividends paid on the shares
A greater payment history of dividends indicates both a return on investment and a reduction of risk associated with the shares, and therefore lowers the discount.
7. The shareholder’s involvement in the business
If a minority shareholder is involved in the business (e.g. on the management team, member of the Board of Directors, etc.), the discount is generally reduced.
8. Court decisions regarding oppressed shareholders
When the Court finds that a minority shareholder has been oppressed by the majority (meaning the court has found that the controlling shareholder has acted against the interests of the minority shareholders), a minority discount is typically not applied.
The Determining Factor is Negotiation
In the case of an open market price, a discount may only be established through negotiation. In a notional valuation context, minority discounts are usually in the range of 10% to 40%. If a seller is motivated to sell, the purchaser may be able to negotiate a higher discount. If the purchaser is motivated to buy, the seller may be able to negotiate a lower discount.
If you’re acquiring a minority interest in a privately-held company, an experienced business advisor can provide the expertise needed to assess the minority discount to be applied to the share value.
To learn more about minority discounts, or for further information about business valuation, contact one of our advisors today for a complimentary consultation.