When working with appraisers, attorneys are likely to grapple with questions about the relationship between two key business valuation concepts involving control exercised over a company.
The first concept is the “lack of control discount,” which, in simple terms, is an amount subtracted from the value of shares because the shareholder lacks all or some of the powers of control over the company. On the other hand, “the control premium” refers to the price premium assigned to controlling shares of a company. Aside from defining the two concepts, attorneys encountering them during the business valuation process may ask:
- How are they related?
- When are they applied?
- What are the appropriate amounts?
- Are there data sources that support these amounts?
In this blog post, the first of a two-part series, we explore these fundamental questions in greater detail.
Levels of Value Overview
A company’s shares have levels of value. The top level (i.e., the most valuable) includes shares with control over the business. In a valuation this would be referred to as the “control value.” On the next level are shares owned by minority shareholders who are able to easily sell (or “market”) their interests on a public stock exchange. The valuation term for these shares is “marketable minority value.” The final level— the “non-marketable minority value”— includes minority shares which are not easily marketable on a stock-exchange and that may have restrictions on their sale or transfer, such as the shares held by a minority shareholder in a privately held company.
Consider the following illustration, which summarizes the levels in a business valuation and the discounts and premiums that may be applied based upon those levels.
As the chart illustrates, a lack of control discount is applied in a business valuation to the marketable control value of a company. In an acquisition, the control value might be thought as the target company value. The marketable minority value represents the publicly traded equivalent value of a company that trades on a stock exchange.
In this post, we are primarily concerned with premiums and discounts assigned to the top two levels of value. For the sake of completeness, however, it’s worth noting that another discount—the “discount for lack of marketability”—would apply to determine non-marketable minority value.
How are Lack of Control Discounts and Control Premiums Related?
To calculate a marketable minority value from a marketable control value, a business appraiser may apply a discount for lack of control. Conversely, to calculate a marketable control value from a marketable minority value a control premium could be applied.
Control premiums are typically obtained from acquisitions occurring in the public market, for which data is available from various sources. Once a control premium is determined, the formula below may be used to calculate the implied lack of control discount.
Data Sources and Choosing an Appropriate Amount
The resource most widely used by business appraisers to obtain control premiums is the FactSet Mergerstat/BVR Control Premium Study database (better known as “Mergerstat”) through Business Valuation Resources, LLC.
The Mergerstat platform is updated weekly, and its sources include Securities and Exchange Commission filings and public announcements for merger and acquisition transactions. The database includes more than 20 years of data and more than 15,000 transactions. At the most generic level, information on control premiums is provided per year for all industries combined. At the next level is annual control premium data separated by industry. The last set is more specific and includes each underlying company involved.
Control premiums can vary widely and there is no hard and fast rule in choosing an amount. However, what if Mergerstat or other resources contain no data related to the subject company or its industry? What option does a business appraiser have in this scenario? We will discuss an alternative to apply control premiums in the second part of our blog series. Stay tuned.
This post is designed to help attorneys understand key business valuation relationships. Should you have any questions about lack of control discounts or control premiums—or any other litigated business valuation issues—or want to learn more about our services and our team, please contact us.