VALUATION DISCOUNTS AND PREMIUMS

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VALUATION DISCOUNTS AND PREMIUMSFundamentals, Techniques & TheoryIt is not really proper to use the term minority discount in all cases. A minority discount is adiscount for lack of control applicable to a minority interest. A discount for lack of control is anamount or percentage deducted from the subject pro rata share value of 100 percent of an equityinterest to compensate for the lack of any or all powers afforded a control position in the subjectentity.Control premiums and discounts for lack of control, sometimes referred to collectively as “controladjustments,” have enjoyed wide acceptance in the federal tax system. The estate and gift taxregulations on valuing publicly traded stock recognize a basic inequality between controlling andnon-controlling interests, noting in Treasury regulation sections 20.2031-2(e) and 25.2512-2(e).“If the block of stock to be valued represents a controlling interest, either actual oreffective, in a going business, the price at which other lots change hands may have littlerelation to its true value.”Regulation sections 20.2031-2(f) and 25.2512-2(f) also list as a factor in valuing closely held stock“the degree of control of the business represented by the block of stock to be valued.” Theseprovisions prompt swing vote consideration as well.The primary IRS ruling on valuation of closely held shares, Revenue Ruling 59-60, clarifies whichway this factor cuts. The ruling states:“Although it is true that a minority interest in an unlisted corporation’s stock is moredifficult to sell than a similar block of listed stock, it is equally true that control of acorporation, either actual or in effect, representing as it does an added element of value,may justify a higher value for a specific block of stock.”Court decisions and rulings employing minority discounts and control premiums have become thestandard over the years, applying these principles not only to stocks, but other types of property aswell. The business valuation community in “non-estate/gift tax” venues also broadly accepts theapplication of these discounts.A. ADVANTAGES OF MAINTAINING A CONTROL POSITION IN A PRIVATELYHELD ENTERPRISE1. Setting company policy and influencing the operations of the business2. Appointing management and determining management compensation and benefits3. Power to acquire and dispose of business assets4. Power to select vendors and suppliers5. Facilitating business reorganizations:a. Business acquisitionsb. Business dispositionsc. Liquidationd. Recapitalizatione. Initial public offering6. Sell or acquire treasury shares7. Power to dictate dividend policy and payments8. Power to revise company organization documents9. Ability to establish or revise buy/sell documents10. Power to block any of the above6 – 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 PREMIUMSB. CONSIDERATION OF OWNERSHIP CHARACTERISTICS IN ASSESSINGCONTROL1. Representation on the Board of Directorsa) Direct representationb) Indirect via cumulative voting shares2. Contractual Restrictionsa) Loan agreements with restrictive covenants3. Other Agreements Including Organization Documentsa) Shareholder agreements setting shareholder responsibilities such as buy/sellagreementsb) Employment agreementsc) Voting Trusts4. Industry Regulationsa) Limiting many advantages of control5. State Corporate Law and Statutesa) Simple majority vs. super majority6. Voting Rightsa) Related to control – the greater the shareholder’s control, the more significant thevoting rights become in the valuator’s determination of value7. Financial Condition of Businessa) Potentially severe control limitations can arise in a business suffering from financialdifficulties8. Size of the Block of Stock Being Valueda) Noted in Revenue Ruling 59-60 as relevant9. Concentration of Ownershipa) A two percent interest in conjunction with two 49 percent interests would invoke alower minority discount than where the remaining 98 percent was held by 10 equalequity owners or a single shareholder.© 1995–2012 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Chapter Seven – 7Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training. 2012.v1
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