Ron J. Lint, ASA, CEO
Business Valuation and ESOP Specialist
ATI Capital Group of Colorado, LLC
3578 Hartsel Dr., Unit E, PMB 321
Colorado Springs, CO 80920
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.