Rules for Minority Discount in Business Valuations
Minority Interest Discount – The concept of minority interest deals with the relationship between the interest being valued and the total enterprise, based on the factors discussed.” “The primary factor on the value of the minority interest in relationship of the minority shareholder interest to the total shareholder interest and how much control the minority interest does have over the particular entity” (Chapter 6, Fundamentals, Techniques & Theory, National Association of Certified Valuation Analysts (NACVA).
The lack of control regards an interest holders inability to make decisions regarding important management and policy actions; such as those listed below, all of which affect the profitability and therefore the value of the company.
- Appointment of management
- Management compensation and perquisites
- Company policies and the course direction of the business
- Acquisition and liquidation of assets
- Selection of customers and awarding of contracts
- Liquidation, dissolution or recapitalization of the company
- Selling or acquisition of treasury shares
- Registration of company stock for public offering
- Declaration and payment of dividends
- Changes to corporate article or bylaws
A minority discount applies when a person or company owns less than a controlling portion of the interest of the company. For instance, when 2 people each own 50% of the interest of a company, no minority discount rules apply, because no one owns less than the controlling interest if the company.
Over the past 13 years three major studies have been conducted to determine the appropriate minority discount. Minority Ownership Interest Discounts range between a Low of approximately 13.8% to a High of 40.0%. The value selected depends on the degree of control that is held with the block of equity being valued based on the factors listed above.
If three people owned a portion of the company dispersed as 50%. 49%, and 1%, only one person has controlling interest whereas two people would have a tied controlling interest if they voted together on an issue. Hence the person who own 1% and the person owning 49% would not actually have 1% or 49% of the value of the company separately because his or her stock has no controlling interest. Their stock would be less marketable than the 50% owner because they have no controlling interest. The person with 50% still has controlling interest because the company is now divided in three and that person would control. Any block of equity being valued that has over 50% ownership would not have a minority discount applied in a business valuation.