by
Ron J. Lint, ASA, CEO
Business Valuation and ESOP Specialist
ATI Capital Group of Colorado, LLC
453 E. Wonderview Ave., PMB 312
970-577-8030
ron@aticolorado.com
Issue: In recent conversations regarding valuation discounts applied
to business interests that are not actively traded on a major exchange
or over the counter, I have noticed a great deal of confusion regarding
when and how these discounts should be applied. Should a minority interest
discount be applied to all valuations representing a minority ownership
position? Are discounts for lack of marketability always appropriate for
privately-held securities? This three-part article explores the two major
discounts often applied to the valuation of privately-held securities.
Discussion: ATI Capital Group of Colorado, LLC (ATICG) divides discounts
into two major groups: primary and secondary. The primary group consists
of discounts considered in virtually all valuation assignments for private
businesses, such as discounts for minority interest and lack of marketability.
The secondary group of discounts only consists of discounts appropriate
in special situations, such as a key man discount, or a blockage discount.
In this article, I will address only the primary discounts, the consideration
of which is appropriate in all private company valuations.
Starting Point of Valuation: Before getting into the specific
discounts, it is important to establish a starting point on the valuation
– a point from which the discount will be applied.
Certain valuation methodologies produce a value considered to be a minority
interest or a controlling interest from the beginning, without applying
a discount or premium to the base number. For example, the use of the
capitalization of net free cash flow method produces a minority interest
value without the application of a discount for minority interest. This
is because the capitalization rate used is produced from public market
rates, and those rates are already considered on a minority basis. A clarification
of this thinking can be found in purchase/sell transactions in public
stocks, which are clearly executed on a minority value basis. Therefore,
in most cases, any methodology that uses capitalization rates or discount
rates, which were developed through the use of public market rates, will
render a value that is already on a minority basis.
Other methodologies will render a value on a controlling interest basis
from the beginning, without applying a control premium. An example would
be the net asset value method, with which is assumed to be on a control
basis to begin. The reason is that minority shareholders would have no
way to get to, take possession of, or dispose of the company's assets.
Such power lies only with controlling shareholders.
Accordingly, when deciding the appropriateness of discounts (or premiums),
one must be aware of the starting point. In some cases, discounts are
appropriate, in some cases they are not. Unfortunately, it is difficult
for the non-valuation professional to make that judgment.
Assuming that discounts are appropriate, our discussion can now turn
to the two primary discounts.
Part One ·
Part Two ·
Part Three
