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51% position sells for a higher price because it provides control over the firm whereas a 49% position
does not.
An equity position of less than 50% of the shares in a firm is called a minority interest. In many
cases, owners of minority interests in private firms do not have much influence or control over the
firm‟s operations and policies. Alternatively, an equity position of more than 50% is a controlling
interest in a firm that generally has power over how the business operates, distributes its profits, and
so forth.
Owning a stock position that has the legal rights to control the firm is more desirable, and investors
usually pay more for that privilege over minority stock positions. In a business valuation analysis, this
idea leads to two types of valuation adjustments. The first sort of adjustment accounts for differences
in value due to the inability to control or influence the firm. The second type of valuation adjustment
accounts for the difference in value arising from illiquidity of the minority shares—which are even
more illiquid than Bob‟s 100% stock interest in the case study. Both of these types of adjustments are
often applied when valuing noncontrolling, minority equity interests in a private firm.
Furthermore, when both adjustments are made, they can be large—perhaps 50% or more from the
equivalent value of a controlling stock interest, all other things being equal. One can reason that this
discount might be so large because noncontrolling interests in most private firms are difficult to sell
and have few legal rights other than getting their portion of whatever the managers decide to distribute
to shareholders. These features make buying this sort of investment not very desirable in most cases.
Business Valuation Standards
Individuals who specialize in business valuation often follow published professional standards when
doing their work. Those guidelines usually cover what one should do in a business valuation analysis
and what should be in a valuation report. In North America, business valuation standards have been
published by several organizations, including the American Institute of Certified Public Accountants,
American Society of Appraisers, The Appraisal Foundation, Canadian Institute of Chartered Business
Valuators, Institute of Business Appraisers, and National Association of Certified Valuation Analysts.
Value Engineering
Just as the CEO of a public firm tries to enhance the value of the shares, managers of a private firm
can work to increase the value of the firm. Some factors can have a large effect on the value of a
private firm. Managers can focus on these factors to possibly increase the firm‟s value in the future.
Some of the factors are obvious, while some are not. The factors include the following:
• Decrease expenses (doing so increases cash flows).
• Increase revenues (increases cash flows).
• Significantly increase the earnings growth rate (may increase earnings forecasts, and lower
the capitalization rate due to the growth factor).