VALUATION DISCOUNTS AND PREMIUMS

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VALUATION DISCOUNTS AND PREMIUMSFundamentals, Techniques & TheoryJ. OBSERVATIONS AND ISSUESUpon analysis of the Mergerstat Review data, it can be observed:1. The annual median control premium observations conducted over this historical period range from27.3 to 44.6 percent2. Mean 35.1 to 59.7 percent3. The dispersion of the premiums is broad with 87 of 326 transactions in 2002 having a premiumunder 20 percent to 42 of the base transactions having a premium over 100 percentHowever, several issues must be addressed in regard to the data:1. Negative premiums are excluded from the median and mean calculations, thereby inflating thecontrol premium data.2. Data for the computations is extrapolated from the reported financial information and not theadjusted financial information both parties might consider.3. The observation methodology does not provide for quantification of buyer differences—specifictransactions result from specific buyers with alternating motives. As such, transactions withsynergistic buyers are interspersed with transactions with financial buyers.The conclusion that the valuation analyst must draw from the above noted issues is thatutilization of the scheduled Mergerstat Review median and/or mean premiums for controlwithout adjustment are likely overstating control premiums in many valuation engagements.Conversely, as many valuation professionals develop the implied minority ownership interestdiscount from the observed premiums, these discounts are also often overstated,underestimating the value of minority ownership interests.K. QUANTIFY THE OVERSTATEMENTDealing with the overstatement is difficult at best, given the limitations related to informationgathered for Mergerstat Review. In 1996, Z. Christopher Mercer attempted to emphasize theoverstatement of the reported mean and median control premiums by arbitrarily modifying thedata inputs into the Mergerstat Review calculations.In his paper presented to the Joint CICBV/ASA conference in Toronto, Mercer recalculated thecontrol premiums (and the implied minority discount) under three alternatives: 41. First, he excluded, as Mergerstat Review does, transactions with control premiums less than zero;but he also excluded those with control premiums over 150 percent.2. Next, he included negative control premiums (less than zero percent) and again excluded thosetransactions with control premiums over 150 percent.3. Lastly, he included negative control premiums and excluded those transactions with controlpremiums over 100 percent.4 Mercer, Z. Christopher. “A Brief Review of Control Premiums and Minority Interest Discounts.” The Journal of Business Valuation(Proceedings of the 12th Biennial Business Valuation Conference of The Canadian Institute of Chartered Business Valuators). Toronto: TheCanadian Institute of Chartered Business Valuators, 1997, pp. 365-87.14 – Chapter Seven © 1995–2011 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved.2012.v1 Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
Fundamentals, Techniques & TheoryVALUATION DISCOUNTS AND PREMIUMSAn example of just how influential the modifications are on the listed premiums can be found inthe following chart (excerpted from Mercer’s 1996 paper):Mergerstat Review Implied MinorityHistorical Control Premiums Interest DiscountsAverages Median Averages MedianAs reported from 1995* 44.7% 29.2% 31.0% 23.0%Exclude < 0% and > 150% 35.3% 28.9% 26.0% 22.0%Exclude > 150%; Include < 0% 28.3% 24.9% 22.0% 20.0%Exclude > 100%; Include < 0% 24.2% 24.0% 19.0% 19.0%* Mergerstat Review excluded two premiums exceeding 100 percent in the reported averages.Also, the reported figures exclude 37 transactions with calculated premiums of less than orequal to zero,Simply including the negative premiums for the fourth quarter 2000 transactions reflect adecrease in the average premium from 44.7 to 31.0 percent. Therefore, it is critical that thebusiness valuator consider the implications of the data modifications in general and theexclusion of negative control premiums in particular.In the January 1999 issue of Shannon Pratt’s “Business Valuation Update,” Dr. Pratt observedthat for the quarter ended September 30, 1998, 20 of 58 reported domestic transactions reportedin the HLHZ Control Premium Study sold at discounts from their prior public trading prices.For the fourth quarter, 2000, the numbers are not quite as sharp with 30 of 147 domestictransactions reporting a discount. This equates to 20 percent of all transactions reported sellingat a discount instead of a premium.Obviously a valuator must be careful, but how does one best develop the appropriate controlpremium? The HLHZ Control Premium Study, which is published quarterly, offers numerousdata points with which specific control premium conclusions can be developed.Each situation should be considered based on its specific facts and circumstances. After anintimate knowledge of the company under valuation is developed, consider the appropriatenessof each of the reported transactions considered for comparison purposes. The valuator mustthen adjust the data to exclude unwarranted/ non-comparable transactions due to the inclusionof acquisition premiums, synergistic premiums and/or consolidation premiums.III. MINORITY DISCOUNTS FOR FAMILY TRANSFERSFor years, the Internal Revenue Service had tried to eliminate minority interest discounts fortransfers of stock in family-owned corporations. Without judicial intervention, such discounts wouldnow be completely disallowed. Despite the directive from the courts to allow discounts in suchcases, until 1993 the IRS attempted to disallow them. In Rev. Rul. 93-12, the IRS formallyrecognized that gifts of closely held stock among family members should be valued separately.However, in subsequent TAMs, the IRS has tried to limit this opportunity by imposing a swing votepremium, collapsing transfers made in contemplation of death and exploiting the discounts in maritaldeduction scenarios.© 1995–2012 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Chapter Seven – 15Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training. 2012.v1
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