Page 38 - Business Valuation for Estates & Gift Taxes

in order to support a lack of control discount or control premium in a valuation report, the valuation ana-
lyst must obtain a thorough understanding of the entity’s business and structure, articles of formation,
regulatory environment, voting rights, and any other relevant information that will provide insight into
how the owners run their business, as well as the external influences that could impact those decisions.
The considerations discussed here are not meant to be all inclusive. Each valuation engagement will pre-
sent unique facts and circumstances; therefore, it is up to the valuation analyst to assess each engage-
ment independently.

Once the degree of control is determined, the valuation analyst will be tasked with placing a value on
that level of control.

Control Value

As noted previously, the premium or discount applied to an ownership interest is based on the degree of
control (or lack thereof) an owner has over the direction and management of the company. Control
should ultimately be viewed as a proxy for future cash flows that an owner expects to receive over the
term of his or her investment or ownership (or both). One generally accepted approach that valuation
analysts use to determine the amount of a premium or discount is to initially value the ownership interest
as if were a marketable minority interest (see exhibit 1). From this point, the valuation analyst would
consider what impact the relevant control features would have on the baseline ownership value (for ex-
ample, cash flow considerations, influence on business decisions, and so on) and adjust upwards accord-
ingly. fn 2

In circumstances when ownership interests are initially valued as a control value (for example, includes
control premiums, usually a pro-rata share of total equity value), it may be necessary for the valuation
analyst to reduce the value of an interest that does not have comparable privileges. This would be done
through the use of a minority interest discount and would result in an ownership interest valued as a
marketable minority interest. fn 3

Non-Controlling Value

Ownership interests not large enough to control operations or make other decisions that affect the com-
pany both operationally and legally are generally considered non-controlling interests. A non-controlling
interest is typically worth less than a controlling interest due to the diminished rights and ultimately a
reduced interest in future benefit streams. The adjustment to reflect this decrease in value is known as a
minority interest discount or discount for lack of control.

A minority interest discount is calculated as the inverse of a control premium. For example, if the minor-
ity value of a stock is $1 per share and an acquirer pays $1.30 per share to buy control, the acquirer has
paid a 30-percent premium over the minority price. This 30-percent premium converts to a 23-percent
minority interest discount as follows.

fn 2 There are a number of publications and studies available that can assist in valuing a control premium. One highly regarded publi-
cation that is updated quarterly is FactSet Mergerstat’s Control Premium Study. Refer to the end of this chapter for other publications.

fn 3 Similar to control premiums, a number of studies and papers exist on how to value minority interest discounts. Valuation analysts
may also determine that it is appropriate to take the inverse of a control premium for a particular privilege and apply it as a discount.

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