Key Takeaways

  • A discount for lack of control (DLOC) reduces the value of a minority shareholder’s interest since they cannot influence key company decisions.
  • Business valuation methods (market, income, and asset approaches) determine total company value before applying discounts like DLOC.
  • DLOC reflects the inability to control management, dividends, liquidation, mergers, or major corporate policy decisions.
  • The size of the discount often depends on empirical studies and business-specific conditions, such as how majority owners treat minority shareholders.
  • Courts and the IRS closely scrutinize DLOC in estate, gift, and trust valuations, making proper documentation critical.
  • DLOC often works in tandem with the discount for lack of marketability (DLOM), but the two address different valuation limitations.

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.

Interaction with Marketability Discounts

While a discount for lack of control addresses voting and decision-making limitations, it is often paired with a discount for lack of marketability (DLOM). DLOM reflects the reduced value of an interest that cannot be easily sold on the open market. Together, these discounts may significantly lower the appraised value of minority interests in private companies. For example, a 20% discount for lack of control combined with a 25% discount for lack of marketability could result in a cumulative reduction of nearly 40% in the reported value of the interest.

Valuation professionals must carefully consider whether both discounts apply independently or overlap, as applying both without analysis could result in double-counting.

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:

  1. 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.
  2. 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.

Factors That Influence DLOC Size

The percentage of a discount for lack of control varies depending on the circumstances of the business and ownership interest. Key influencing factors include:

  • Ownership percentage: The smaller the shareholder’s stake, the less influence they generally have, increasing the discount.
  • Shareholder agreements: Preexisting agreements (like buy-sell clauses or supermajority requirements) can limit or expand minority rights.
  • Industry norms: Some industries give minority investors more protections, while others grant wide latitude to majority shareholders.
  • Dividend history and policies: If dividends are irregular or withheld, the value of minority shares is reduced.
  • Liquidity of shares: Even if control is lacking, shares that can be readily sold may warrant a smaller discount.

Courts often look to empirical studies comparing publicly traded companies’ minority vs. controlling stakes, but adjustments are made when specific company conditions differ.

DLOC in Estate, Gift, and Trust Tax Valuations

Discounts for lack of control are particularly important in estate planning, gifting, and trust administration. By applying DLOC, families can transfer business interests to heirs at a lower taxable value. However, both the IRS and courts scrutinize these discounts closely, requiring valuation experts to justify them with data and analysis.

For example, if a parent transfers a 30% non-controlling interest in a family-owned business, the value reported for tax purposes may reflect a DLOC adjustment. If the appraiser fails to document the rationale, the IRS may challenge the discount, potentially leading to penalties and higher tax obligations.

DLOC vs. DLOM: Key Differences

Although often used together, DLOC and DLOM represent different valuation concepts:

  • Discount for Lack of Control (DLOC): Reflects the reduced value due to inability to influence management, dividends, or company policies.
  • Discount for Lack of Marketability (DLOM): Reflects reduced value because shares cannot easily be sold or converted into cash.

For instance, a 10% shareholder in a private company may face a DLOC because they cannot dictate board decisions, and a DLOM because they cannot sell their stake quickly without a buyer. Recognizing the distinction ensures that valuation adjustments are applied fairly and not duplicated.

Frequently Asked Questions

  1. What is the typical range for a discount for lack of control?
    Studies often show DLOC ranges from 15% to 35%, but the exact percentage depends on company size, industry, shareholder agreements, and dividend practices.
  2. Can both DLOC and DLOM be applied together?
    Yes, but experts must ensure they measure different risks. Overlapping adjustments may lead to double-counting, which courts and the IRS may reject.
  3. How does the IRS view discounts for lack of control?
    The IRS carefully examines DLOC in estate and gift tax cases. Discounts must be well-documented and supported by empirical data or company-specific evidence.
  4. Is DLOC always applied to minority shares?
    Generally yes, but if valuation methods already account for minority status, a separate DLOC may not be necessary.
  5. Why are empirical studies important in DLOC valuation?
    They provide benchmarks by comparing controlling vs. minority share transactions in public companies, helping appraisers estimate an appropriate discount for private businesses.

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