A minority discount represents an amount or percentage deducted from the value of a company's shares. A minority discount is applied to reflect the absence of some of the controlling powers. The discount may also be applied because a minority interest is illiquid and therefore more difficult to trade than a controlling interest.
The fact that a minority shareholder usually lacks the ability to make management decisions (such as, for example, setting any bonuses or proceeding to sell the company) is the main reason for applying minority discounting.
What factors (potentially) affect minority discounting?
There is no defined mathematical formula to quantify a minority discount and its potential impact. The discount is usually determined based on a number of considerations, including:
1. General
The larger the size of the minority interest, the lower the discount will be.
2. Relationships among shareholders
Relationships among shareholders can affect the size of the discount. For example, if a company is controlled by a group of minority shareholders acting in concert on voting matters, it may be opined that no discount should be applied to the value of the shares of any member of that group if that group collectively controls the company.
3. Provisions in the shareholder agreement
If there are provisions in the shareholder agreement that provide for the liquidity of a minority interest then the discount will be reduced. Such a provision is, for example, the stipulated possibility of selling the minority interest back to existing shareholders/to the company.
4. Provisions in the bylaws to protect minority interest.
Such protections in the bylaws represent a lower risk to the minority shareholder which will result in a lower discount.
5. Previous discounts granted
Previous sales of minority interests may set precedents regarding adequate discount for minority shares.
6. Involvement in the company
If a minority shareholder is actively involved in the company (a member of the management team, a member of the board of directors, etc.) then the discount is generally reduced.
7. Court decisions involving minority shareholder
If the court finds that a minority shareholder has been oppressed by the majority (i.e., the court has found that the controlling shareholder has acted contrary to the minority shareholder's interests), a minority discount is generally not applied.
Bargaining is the determining factor
In the case of an open market price, a minority discount can and will only be determined through negotiation.
In the case of a notional valuation context, discounts are usually in a range between 10% and 40%. If a minority seller is motivated to sell then a buyer will be able to negotiate a higher discount. Otherwise, the minority seller will be able to negotiate a lower discount.
