Valuation, a meticulous art that deciphers the worth of a business, is multifaceted. Business valuation is about understanding a company’s inherent worth but recognizing the variables that arise based on the stake in question: a controlling stake versus a minority stake. In the arena of investment banking, particularly in the lower middle market, understanding these distinctions is paramount.
The Distinctive Nature of Controlling and Minority Stakes
A controlling stake, typically 50% or more of a company’s equity, provides the holder with decision-making power. With it comes the ability to influence business strategies, operations, and financial decisions. In contrast, a minority stake, usually less than 50%, doesn’t offer the same level of control.
The Impact of Control Premium
Oftentimes, a controlling stake commands a “control premium.” This is because acquiring control opens doors to strategic changes, potential synergies, and restructuring opportunities. According to studies conducted by National Association of Certified Valuators and Analysts (NACVA) and other authoritative organizations, control premiums can range from 10% to 50% over a minority stake’s per-share value, depending on the specific circumstances.
The Minority Discount: A Closer Look
A minority stake often comes at a discount, a reflection of its limited influence. The “minority discount” considers the lack of control, the potential illiquidity of the shares, and the inability to determine the company’s future course. The American Institute of Certified Public Accountants (AICPA) and other prominent valuation bodies have highlighted that minority discounts can range between 20% to 40%, depending on the minority shares’ protective provisions, industry, company size, and other intrinsic factors.
Minority Interest Discount Defined
The concept of minority interest delves deeper into the relation between the valued interest and the total enterprise. As per Chapter 6, Fundamentals, Techniques & Theory by the National Association of Certified Valuation Analysts (NACVA): “The primary factor on the value of the minority interest is the relationship of the minority shareholder interest to the total shareholder interest and the extent of control the minority interest holds over the particular entity.
The Role of Protective Provisions
Protective provisions play a pivotal role in enhancing the value and rights of minority shareholders. Contractually embedded within shareholder agreements, these provisions are designed to shield minority shareholders from potential unfair treatment and give them a say in critical business decisions. Specifically, these clauses can bestow rights such as veto power on significant decisions, rights of first refusal on share transfers, and assurances on dividend distributions.
The potency of these provisions is directly proportional to the influence they grant: robust protective provisions can notably reduce the minority discount by elevating the value and security of the minority stake.
On the other hand, weak or absent provisions can increase the minority discount, reflecting the diminished protection and influence for minority shareholders. In essence, protective provisions act as a balancing force, ensuring the valuation accurately captures the minority stake’s true influence and security within the company.
Factors Driving Minority Discounts
Leading organizations, such as the NACVA (National Association of Certified Valuators and Analysts), have extensively researched the typical discounts associated with minority stakes. Their findings emphasize that discounts can fluctuate substantially based on several variables. Notably, sectors marked by high volatility or those facing challenging industry headwinds often experience steeper minority discounts. In contrast, enterprises operating within stable, high-growth sectors might benefit from reduced minority discounts.
Several key factors play a significant role in influencing the depth of these discounts:
- Liquidity and Marketability: Shares that are readily marketable and can be easily converted to cash tend to have lower discounts. In contrast, shares in private companies, which might lack a ready market, often face higher minority discounts due to their reduced liquidity.
- Access to Information: Minority shareholders’ ability to access comprehensive and timely company information can influence discounts. Greater transparency and information availability can lead to reduced discounts as it mitigates risks associated with asymmetric information.
- Distribution Rights: The assurance or lack thereof regarding dividend distributions can sway the minority discount. A minority stake that comes with consistent dividend distribution rights is likely to have a smaller discount compared to one without such guarantees.
- Existence of Buy-Sell Agreements: The presence of a buy-sell agreement can dictate the terms of future share sales. Such agreements can either mitigate or exacerbate the minority discount, depending on the terms laid out and their favorability to the minority shareholder.
- Potential for Blockage: This refers to the inability to sell large blocks of stock without adversely affecting the stock price. A higher potential for blockage can increase the discount as it signifies that selling the stake might be cumbersome and potentially less profitable.
The Nuances of Control
Lack of control often centers on an interest holder’s inability to steer key management and policy decisions, all of which significantly impact the company’s profitability and, consequently, its valuation. Decisions might include:
- Appointment of management
- Management compensation and perquisites
- Directing company policies and business course
- Asset acquisition and liquidation
- Selecting customers and awarding contracts
- Company liquidation, dissolution, or recapitalization
- Sale or acquisition of treasury shares
- Registering company stock for public offering
- Declaring and paying dividends
- Altering corporate articles or bylaws
Given the myriad of factors at play, businesses and investors must adopt a nuanced approach, assessing each factor’s weight in the context of the specific company and industry dynamics.
Empirical Data on Minority Discounts
Over the past 13 years, substantial research has been undertaken to determine appropriate minority discounts. Findings reveal that Minority Ownership Interest Discounts oscillate between a low of approximately 13.8% and a high of 40.0%. The chosen value hinges on the control degree associated with the equity block under valuation, in line with the aforementioned factors.
Astria Group’s Expert Insight
Drawing from a reservoir of experience in lower middle market private equity and investment banking on top of our valuation expertise, Astria Group brings significant acumen to stake-specific valuations. We appreciate that the nature of the stake — control or minority — profoundly impacts the valuation, and our tailored approach caters to these nuances, ensuring that the stake’s intrinsic and relative values are both captured comprehensively.
Illustrating Control through Ownership Scenarios
The dynamics of control are clearer in practical scenarios. Consider a situation where two individuals each own 50% of a company. In this case, no minority discount applies as neither holds less than the controlling interest. However, in a scenario where ownership is split as 50%, 49%, and 1%, the dynamics shift dramatically. Here, only the 50% owner retains a controlling interest, while the other two, even when combined, lack this. Their respective stakes would be less marketable due to the absence of control. Notably, any block of equity exceeding 50% ownership wouldn’t face a minority discount in a business valuation.
Understanding the differences between valuations for controlling and minority stakes is not just about numbers—it’s about interpreting the layers of influence, rights, and protections that accompany each stake. At Astria Group, we delve deep into these intricacies, offering a valuation perspective that is both informed and strategic.
Engage with the Experts
Thinking about making an investment or maybe selling a part of your business? Valuations can be a tricky business, full of tiny details and big decisions. That’s where Astria Group comes in.
Our team of M&A professionals and valuation experts are here to break things down for you. We’ll chat through the complicated stuff, answer your questions, and help guide your choices.
With us by your side, you’ll feel more confident and informed about your next steps. Let’s have a conversation, and make sure you’re set up for success. Contact us today!