Value of Minority Interest is Lower Because of Lack of Control
It comes as a surprise to many that a minority interest in a privately held company is worth less than its proportionate share of the company taken as a whole. These people often think that a 15% interest in a company that is worth $1,000,000 should be worth $150,000. This is a sometimes hazardous notion.
Well-trained appraisers and experienced investors know that minority interests (often called non-controlling interests) are worthless—substantially less—than their proportionate share of the value of the company. Controlling shareholders enjoy many benefits that are not available to non-controlling shareholders.
Benefits of Control. Among the benefits reserved for controlling owners are:
• The ability to appoint or change management;
• The ability to control the Board of Directors;
• The ability to set management compensation and perquisites;
• The ability to liquidate, sell-out, or recapitalize the company;
• The ability to pay (or not pay) dividends to shareholders;
• The ability to acquire, lease, or liquidate business assets;
• The ability to negotiate mergers and acquisitions; and
• The ability to control the operation and course of the company’s business.
Majority Controls Dividends. From a practical standpoint, the owner of a less-than-controlling interest in the company is at a severe disadvantage compared to the owner of the controlling interest. The controlling shareholder/manager is under no obligation to pay any portion of the profits to other shareholders. Where the controlling shareholder is also the manager or president of the company, he will sometimes set his own compensation so high that no profits are left over to pay to other shareholders as a return on their investment.
Other times controlling shareholder/managers will hire family members and pass on to them as compensation the profits that might otherwise go to non-controlling shareholders. Far from the exception to the rule, this is a common occurrence in many small privately owned companies.
No access to Value of Assets. Many minority shareholders believe that because the assets of the company have value, that the value of their share is protected by the value of the underlying assets. This is seldom the case. Ownership of stock in a company does not grant the shareholder any portion of the ownership of the underlying assets. In the first place, the creditors of the company will always be in line ahead of shareholders if the company is liquidated, and the controlling shareholder can control the liquidation of the assets.
For all of these reasons, it’s well-settled law that a non-controlling interest is in most cases worth less per share than a controlling interest.
Unfortunately, there isn’t a book where the extent of the minority discount that should be applied can be looked up by the appraiser. It depends on the nature and extent of the infirmity suffered by the controlling shareholder. This infirmity, the opposite of the advantage enjoyed by the controlling shareholder, depends on such factors as the relative sizes of the blocks held by the controlling shareholder and the non-controlling shareholder; the rights and benefits set forth in the shareholders’ agreement, rights and duties of controlling shareholders set forth in law, and the attitude and historical patterns of the controlling shareholders in paying dividends out to minority shareholders.
Many Appraisers Rely on Benchmarks. In many cases, business appraisers rely on benchmarks for minority discounts derived from control premia paid by acquirers of controlling interest in other companies. The implied minority discount is the inverse of the control premium paid by the acquirer. There are many reasons why this is an imperfect measure of the minority discount, but it is about the best source of observed market data available. According to recent compilations of these control acquisitions, the median implied minority discount is about 30% of the value of the stock (for large companies).
Minority Discount for Smaller Companies May be More. For small companies, the discount can be very much greater than this figure because the typical controlling shareholder in a small business has far greater power than management of the size companies typically acquired. Some appraisers believe that non-controlling interests in small privately held companies are entirely worthless.