The valuation of privately held firms, including those in the A/E industry, usually involves discounting to arrive at a concluded value of the subject interest. To place a value conclusion on a privately held business interest, we must determine the level at which the valuation will be done — a control interest basis or a minority interest basis. An owner of a 51-percent or greater interest is considered a “control” owner, and a holder of 49 percent or less is considered a “minority” owner. In the context of fair market value, the levels of these two types of owners are significantly different. It would be easy to assume that the value of a minority interest in a privately held firm is equivalent to the pro-rata value of a 100-percent interest, but that is not the case. Issues of control and marketability must be taken into account.
The other contributing factor for a valuation professional to determine discounts is the methodology employed in the appraisal process. Various approaches to value can produce results on a different basis.
Asset approach — Under an asset approach, no individual shareholder owns the corporation’s assets at the individual level; shareholders with a majority position and voting control have the ability to control the corporation and the accumulation or disposition of the assets. Therefore, the control shareholders have access to the equity in the assets and asset-based methodologies produce values at the control level.
Income approach — Depending on the appraiser’s decision as to the level of normalizing adjustments to the financial statements, income approach methodologies can produce a value indication at the control or minority interest level. If “control” normalizing adjustments are made, the value indication is at the control level. The opposite is true if the only normalizing adjustments made are those applicable to what a minority interest holder could affect.
Market approach — The transaction data used in a market approach methodology will have a direct correlation to the level of value produced. Privately held company transactions are representative of a control interest; public company data is representative of minority interests.
With this brief review of the approaches and the levels of value produced, let’s get to the discounts.
Discount for lack of control — A discount for a minority interest is taken from a control level value indication to account for the lack of control associated with a minority shareholder. Studies which suggest the size of the minority interest discount are based on control premium studies, resulting in implied discounts of about 25 percent. To properly develop an appropriate discount for a subject interest, an appraiser should consider several factors that could increase or decrease the discount, including non-voting interests, extreme lack of consideration of minority shareholders, an interest insufficient to stop corporate action or elect a director, the existence of put rights, and the presence of enough minority owners sufficient to block certain actions or have meaningful input on elections of directors.
Discount for lack of marketability — A discount for a lack of marketability is meant to account for the lack of liquidity (or marketability) of stock that is not traded on public exchanges. Studies result in a range of discount from about 10 percent to 35+ percent. Multiple factors can impact the appropriate discount for a subject interest, including transfer rights, dividends or the lack thereof, the prospect of selling the firm, the existence of a market for the block of shares being valued, put rights, the existence of a buy-sell agreement, and stability of earnings.
What shareholders should take away from this brief discussion is that every decision made within a firm — from financial to corporate governance — has an implication on the final value conclusion.
Tracey D. Jeffers, MBA, CBA, CMEA, is a senior consultant in ZweigWhite’s Financial Advisory Services Group where she oversees valuation services. Contact her at firstname.lastname@example.org or 479-582-5700.