The Minority Discount
A minority discount refers to a reduction applied to the valuation of a minority equity position in a company due to the absence of control and power held by the minority shareholder or interest holder. Unlike majority equity holders, minority holders lack the ability to influence critical decisions such as the company's strategic direction, the appointment of directors or managers, the timing and nature of investment returns, and the sale of their equity positions. This lack of control diminishes the value of the minority equity position relative to the total company value. Consequently, potential buyers may be less inclined to acquire a minority equity position compared to a majority one, as majority ownership offers greater power, control, and reduced risk. For instance, consider a scenario where a corporation has two shareholders with 1000 shares in total, and the majority shareholder holds 600 shares, granting them a 60% voting power in the company. Any decisions requiring a majority vote would be under the complete control of the majority shareholder. As a result, a reasonable individual looking to acquire an interest in the company would not value each share equally. Instead, the shares held by the majority shareholder would be valued higher than those held by the minority shareholder. When selling a minority share, meaning a less-than-controlling interest in a privately-held business, a minority discount may be applied to the pro-rata share value. Business valuators consider various factors to determine this discount, and here are 8 significant considerations:
1. Size of the Minority Shareholding: Generally, the larger the minority shareholding, the lower the discount.
2. Relationship Between Shareholders: The relationships among shareholders can influence the extent of the minority discount. If the corporation is controlled by a group of minority shareholders who act collectively in voting matters, it may be argued that no minority discount should apply to a member of that group since the group collectively controls the company.
3. Impact of Shareholders' Agreement Provisions: Provisions in the shareholders' agreement that offer liquidity to a minority interest, such as the option to sell shares to existing shareholders or back to the company, can reduce the discount.
4. Provisions in Articles of Incorporation and Statutory Rights: Protections granted to the minority interest reduce risk and subsequently lower the discount.
5. Precedents from Prior Share Sales: Discounts established in previous share sales can set a precedent for the appropriate discount for minority shares.
6. History of Dividends Paid: A consistent payment history of dividends indicates a return on investment and reduced risk associated with the shares, leading to a lower discount.
7. Shareholder's Involvement in the Business: If a minority shareholder actively participates in the business (e.g., part of the management team or the Board of Directors), the discount is generally reduced.
8. Court Decisions on Oppressed Shareholders: When a court finds that a minority shareholder has been oppressed by the majority, a minority discount is typically not applied. In an open market transaction, the discount is established through negotiation. In a notional valuation context, minority discounts generally range from 10% to 40%. The specific discount may be influenced by the motivation of the seller or purchaser. An experienced business advisor can provide the necessary expertise to assess the appropriate minority discount when acquiring a minority interest in a privately-held company.
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