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
(see part one).
Discount for Lack of Control: The first of these primary discounts
is a discount for lack of control (also known as a minority interest discount).
A minority position in a stock is worth less than a comparable control
position because the minority interest holder lacks the prerogatives of
control, such as hiring and terminating employees, making contracts, setting
policy and compensation, for example. The standard of value, therefore,
is the amount at which a hypothetical willing buyer/willing seller would
conduct a transaction. A buyer is not going to pay for control if he receives
only a minority interest.
Having established a need for a minority interest (lack of control) discount,
the question is how should it be established. At ATI, we use Mergerstat
Review, published by Merrill Lynch, which follows transactions all over
the country involving mergers, acquisitions and sales of all types of
business interests. The latest quarterly report of Mergerstat Review indicates
that the average minority interest discount is 43%. The valuator should
then consider whether the subject company is average, or should be adjusted
from average, one way or the other. Having made this determination, the
discount is applied to the Freely-Traded Controlling Interest Value, resulting
in the Freely-Traded Minority Interest Value. The minority interest discount,
as will next be discussed, is always applied prior to the discount for
lack of marketability. Remember, in order to apply this discount, the
base from which was started must be the Freely-Traded Control Value, otherwise
the discount is not appropriate.
Discount for Lack of Marketability: The valuation conclusions
reached from using most standard valuation methodologies have the attributes
of a marketable investment. This type of value is not appropriate for
a privately held company because it is not actively traded on an open
exchange and, in fact, has no ready market for its shares. Although there
may be interested buyers for such a company, it would take longer to sell
shares in a private company than shares in a publicly traded company.
Furthermore, selling shares in a private company that was considering
an IPO would be considerably more expensive, due to flotation costs, than
to sell shares in an actively-traded company. For these reasons, a discount
for lack of marketability is appropriate. Such discounts average 35-40%,
but can range from 5-70%.
The market places a far greater value differential on the liquidity factor
in its pricing of common stocks than in its pricing of any other class
of investment assets.
Part One ·
Part Two ·
Part Three
