Discount For Lack of Control: Everything You Need to Know
A discount for lack of control is the reduction in a company’s share value due to a shareholder’s lack of ability to exercise their control over the company.3 min read
2. Lack of Control Valuation
A discount for lack of control is the reduction in a company’s share value due to a shareholder’s lack of ability to exercise their control over the company. This is almost always considered to be worth less than a controlling interest in a company since business decisions, like determining compensation, setting policies, deciding to sell or liquidate, and declaring dividends, are all out of the shareholder’s hands. Thus, when non-controlling or non-voting shares are valued for a private company, a discount for lack of control is often applied.
Total Corporation Valuation
Before determining a discount for lack of control, it is first necessary to calculate a corporation’s total value. When a privately held company is valued, the three most common approaches to arrive at that value are:
- The market approach. This determines value by comparing the business to others of similar size in the industry. It is the most intuitive approach.
- The income approach. This determines value by projecting the future profitability of a business by calculating its revenue stream. It is the most technical approach.
- The asset approach. This determines value by simply adding the value of a corporation’s assets together. It is the most straightforward approach.
Once the company’s entire value has been determined, potential discounts from this value must be considered, one of which is the discount for lack of control.
Lack of Control Valuation
A discount for lack of control takes into account the benefits of control not available to a company’s minority shareholders, which may include, but are not limited to:
- The ability to change or appoint management.
- The ability to have control over the board of directors.
- The ability to control management compensation.
- The ability to sell, recapitalize, or liquidate the company.
- The ability to pay shareholder dividends.
- The ability to lease, liquidate, or acquire business assets.
- The ability to negotiate acquisitions and mergers.
- The ability to control the company’s course of business.
- The ability to award contracts.
- The ability to acquire or sell treasury shares.
- The ability to put the stock up for sale to the public.
- The ability to change the bylaws and articles of incorporation.
A lack of control’s impact on the value of ownership is usually reflected in one of the following ways:
- The benefit stream for the market and income approaches of valuation will not be adjusted for any control-related items, which may include the discretionary expenses of owners or the overcompensation of officers, so the values that result from this are considered to be non-controlling.
- The lack of control’s discount can be applied to arrive at a non-controlling value if the applied valuation methods derive the controlling ownership interest’s value, as may be the case with income/market-based approaches or the adjusted net asset method.
Whether or not applying a discount for lack of control is appropriate for non-controlling shares depends on the data and methods used to calculate the pre-discount share value. If the valuation method has a lack-of-control discount already included in the calculation, then a further discount for lack of control is not necessary. However, if such is not the case, then the discount may be based on:
- Empirical studies.
- Conditions unique to that particular business.
- Both empirical studies and unique conditions.
Conditions unique to the business might include the degree that the controlling shareholder or shareholders act against the interests of the non-controlling shareholders. If no such conditions exist that could sway value to a great degree, then empirical studies might be more appropriate.
Empirical studies will designate a premium price that should be paid for controlling interest in the corporation and contrast that to the amount the corporation’s non-controlling shares were trading for in the market before purchase, thereby arriving at the appropriate discount. Such a calculation is easily done, but nonetheless, caution should be used in relying solely on such studies, as in most cases, some intangible elements that cannot be calculated will also be appropriate to consider when determining value.
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