Minority Discount in Business Valuations
Is a quarter of the cake worth a quarter of the whole cake?
The concept of the minority discount comes up regularly in the valuation of private companies including in divorce cases and shareholder disputes. When valuing shareholdings of less than 50%, the application of a minority discount can have a very significant impact on the valuation. For example, say the valuation of the mythical company Black Forest Ltd is £10 million. Mr Cherry, a shareholder, has a 25% shareholding and so it might be assumed that his 25% shareholding is worth £2.5 million.
In my experience the parties to a dispute often overlook the relatively significant impact of minority discounts when assessing the high-level valuation of their shareholding.
However, if a minority discount is applied - and adopting the figures in the ACCA Technical Guidance 167 - a discount of 45% to 55% may be applied. For example, using a 50% discount reduces the value of Mr Cherry’s shareholding from £2.5 million to £1.25 million.
What is a minority discount?
In essence a minority discount reflects the lack of influence that a minority shareholder has. The discount reflects the lack of control, marketability and reduced negotiation power of the minority shareholder in contrast to the majority shareholder. The majority shareholder can determine dividend policy and can control certain votes at the Annual General Meeting. The minority shareholder may have restrictions in terms of the sale of their shares and the marketability of a minority shareholding is typically limited.
Valuers will make a distinction between the market value of a shareholding and its fair value. The market value is the value of a particular shareholding in the open market and therefore takes into account the size and influence of that shareholding. The fair value is the pro-rata value of the shares and ignores any minority discount.
What factors determine whether a minority discount applies?
Ultimately in matrimonial cases and shareholder disputes where I provide valuations, the Court will decide if a minority discount should be applied. However, as the expert valuer and in order to assist the parties, I will give a view on whether a minority discount should be applied and what percentage might be applied.
A starting point is to review the Articles of Association and any Shareholder Agreement to see if these include any stipulations as to the application of a minority discount and any other terms regarding the rights of minority shareholders. Often the Shareholder Agreement will include provisions on how a minority shareholding is to be valued and whether a minority discount should be applied.
I will also consider the concept of a “Quasi Partnership”. The term refers to whether the day-to-day operation of the company is akin to the operation of a partnership. If the company is formed based on the close personal relationships of the shareholders, the Court may infer it should be treated as a partnership and no minority discount is applied.
Other factors to be considered will be the make up of other shareholdings and the relationship between the shareholders, the dividend history and whether there are any lock-in provisions.
Each situation has its own nuances. However, if the parties or court are looking for a “fair result” the minority discount will be reduced or ignored.
What size is the minority discount?
The determination of the percentage of discount to be applied is subjective; there is little published guidance. The ACCA Technical Fact Sheet 167 (May 2011) is one of the few articles which is currently available and so is typically referred to by expert valuers. This Fact Sheet gives the following guidance for the level of discount depending on the size of shareholding.
- Majority holdings in excess of 50: a discount of 5% to 10%
- 50% Interests: a discount of 15% to 25% depending on the split of the other interests
- Interests of 26% to 49%: a discount of 30% to 40%
- Interests of 10% to 25%: a discount of 45% to 55%
- Interests of less than 10%: a discount of 60% to 75%
However, the Fact Sheet makes it clear that this is guidance and the particular circumstances must be considered. It also notes that the discounts are likely to be less in matrimonial cases and shareholder disputes. It mentions that in some situations the minority shareholder may be strategically important and thus the discount is considerably reduced or removed.
Conclusion
Unfortunately for Mr Cherry, 25% of the cake may not be worth 25% of the whole cake. However, in each situation the valuer will consider the size of shareholding and other shareholdings, the rights and contractual position, the way in which the parties managed the company and negotiating position of the parties.
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