When considering your business valuation and business risks in the hopes of selling that business, there are many factors to consider. One important factor to understand is the application of valuation discounts. The valuation of a controlling interest versus a minority interest within a privately held business can have different values, depending on the circumstance. Due to the inherent differences between controlling and minority interests, the value of a minority interest is not equal to its pro rata portion of the whole. This is a direct result of the application of minority interest and lack of marketability discounts.
Minority interest discounts reduce value in order to reflect the minority interest’s inability to control the company’s management and policies. When quantifying the minority interest discount, the valuation analyst must consider several factors that include – the voting rights of the minority interest, the level of control and associated benefits of the minority interest, the contractual agreements in place between the owners, and relevant state law.
Lack of marketability discounts reflect the difficulty an investor would have in selling an ownership interest. Typically, investors consider the liquidity of an interest (i.e., how quickly it can be converted into cash at the owner’s discretion). Therefore, the market will pay a premium for liquidity or, conversely, exact a discount for lack of it. Factors affecting a privately held business interest’s marketability include – transfer restrictions, dividend-paying policy, size of the block of stock, and whether the owner possess elements of control.
The application of valuation discounts depends on the level of value indicated by each method used by the valuation analyst. If all methods utilized indicate values at the same level, applicable discounts may be applied at the conclusion of the valuation. However, if the methods utilized indicate values at different levels, then appropriate discounts would be applied separately to each individual method.
It is important that the valuation analyst apply appropriate valuation discounts to adjust the level of value indicated in the valuation method to the level of value being estimated in the valuation assignment. Failure to comply with the proper application of discounts can result in a serious distortion to the estimate of value and result in a meaningless valuation conclusion.
Although the application of appropriate valuation discounts is left at the professional judgment of the valuation analyst, a qualified appraiser can support discounts that will withstand IRS scrutiny and appropriately estimate the interest being appraised.