Discount for Lack of Control: The Ultimate Guide
When it comes to valuing shares in a company, there are two distinctive categories: the majority and minority owners. It is important to create that distinction because it recognizes the difference in value once control is part of the conversation. When dealing with a company that has multiple owners, control is critical, and most people are willing to invest more if it means having more control over business decisions. For this reason, there is a concept known as discount for lack of control.
When negotiating your share value in a company, it pays to know what this means and how you can make the most of it.
What is Discount for Lack of Control?
Discount for lack of control is a vital aspect to consider when it comes to buying or selling a business. It is of particular interest to a buyer who may place a higher value on an ownership interest that gives them the power to make changes or contribute to business decisions at their discretion. On the flip side, buying ownership in a company wherein there is a lack of control may not be as attractive for buyers.
Simply put, buyers of businesses generally seek control. They will be less likely to pay a significant amount on an investment if it means they lack control.
Whenever valuing businesses wherein the ownership being sold has lack of control (also known as non-controlling business interests), a discount is inherently offered. The discount is offered to reflect the non-controlling position that the buyer has within the company or organization. This value is lowered or discounted from the prorated value per share offered for all other buyers. Depending on the type of company, the discount offer will range from 5 to 40%.
When you consider all other factors in the purchase of a new business, a non-controlling ownership position is considered less desirable, and it is reflected in the valuation of the sale.
How is Discount for Lack of Control Determined?
There are several factors that are taken into account when assessing the total value of discount given for minority buyers of a company. Not all of these factors apply in all instances of business sale, but if they are present, then they can certainly have an impact.
Factor 1: Ability to Influence Management Decisions
This is the most important factor that is used to evaluate the discount for lack of control. Most owners – minority or majority – of a business aspire to have a say in the management decisions of the entity. The ability to influence management decisions will depend on the number of directors and the board.
A discount is given to minority owners that have lack of influence with the management decisions, including the declaration of dividends.
Factor 2: Divided History
The financial information and dividends history of an entity is another critical factor that will impact the actual discount valuation when buying a non-controlling interest in a company. The lack of dividends history can impact the amount of discount you get as it reflects the company’s insufficient cash flow. On the flip side, a good dividend history can reduce the DLOC due to the potential to earn consistent dividends as a shareholder, even with a lack of control.
Factor 3: General Control Premium Data
The empirical data within a business entity can have an impact on the discount value that a non-controlling interest gets when buying a particular share. It will take into account the interest of the shareholders, particularly when one shareholder holds higher control over the others. Any historical data on the discounts offered to non-controlling interests will also play a factor in the calculation.
Factor 4: Other Considerations
There are other considerations that will have to be taken into account in order to determine the discount offered to buyers who want to obtain non-controlling interest in a business entity. The following are a few other factors that can directly or indirectly impact the discount valuation:
- The ability of a party to control the company’s capital structure (such as issuing new shares or repurchasing of outstanding shares).
- The ability of a party to decide when the entity enters a contractual relationship with customers and/or suppliers.
- The ability of a party to make decisions on the company’s dividend policy.
- The ability of a party to decide on the capital expenditure programs.
- The ability of a party to block or veto actions that impact management and operations of a business entity.
What is a Typical Discount for Lack of Control?
There is a specific formula employed by the business appraisers when determining the exact value of discount offered to the buyers. A baseline DLOC is applied based on the empirical data for that entity or any other entities in the same industry. From that baseline value, the actual discount given will go up or down according to the specific attributes of the entity being valued.
A good example of this would be the economic attributes of the company. The more economic power the entity has, the more the shareholders would want control over the policies and decisions of the organization. For this reason, the value will naturally increase, and more discounts will be merited for non-controlling parties.
You might also like to read: How to Value a Business Based on Sales
As mentioned above, the discount rate for lack of control can be as low as 5% or as high as 40%. However, the exact figures will be determined upon the finalization of the sale agreement as the valuation of the business will also vary on a case-to-case basis (and can be influenced by external conditions such as prevailing market trends).
Business buyers must be equipped with the facts and circumstances of a business they are interested in before they make an investment. Most people, especially business leaders, like to take charge and make critical business decisions. Losing that control in an entity you have invested in does not seem appealing.
If you must pursue this type of investment, make sure you have properly evaluated the discounts that are applied and ensure they are appropriate for the company and interest being valued. Pay closer attention to the specific factors that impact the business, as this can be critical in making the correct decision.