A minority interest is almost never simply a proportional share of the total enterprise value: 25 percent of the shares does not always equate to 25 percent of the value. The valuation also takes into account the shareholder’s position, their control rights, and the marketability of the stake. As a result, a discount is often applied—research shows that this can vary between 25 and 90 percent.
Minority interests are common in small and medium-sized businesses. For example, when bringing in an investor or during a partial acquisition. But how do you value such a minority interest? “This is one of the trickiest topics in the world of valuation.”
From the start, valuing a minority stake is not very different from valuing a business as a whole. The devil, as so often, is mainly in the tail. In that final stage of a valuation, register valuators must make a translation between the total shareholder value on the one hand and the value of a shareholder's minority interest on the other.
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“Many entrepreneurs think that 40 percent of the shares equals 40 percent of the total company value, but that’s not always how it works,” says Frank van der Noll, partner at Berghout + MAS Accountants & Advisers. “Among other things, you also have to take into account the position of the minority shareholder, what control rights are attached to that stake, how marketable the minority stake is, and what type of shares are involved.”
What types of minority shareholders are there?
There are various ways in which someone can “acquire” a minority interest. A minority shareholder who buys into a company and gradually takes over often starts with a minority stake. Or an investment firm that provides a capital injection to a startup stipulates a minority stake, because the entrepreneur must take the lead. But consider also an employee who receives a small number of shares as a reward. Or a family business that distributes its shareholding among the entire family, creating all kinds of “small” shareholders.
Now imagine that each of these types of shareholders (MBI investor, investment firm, employee, and family member) holds the same 25 percent stake in the same small-to-medium-sized business. You might expect everyone to hold a stake of equal value, but that is precisely the crux of valuing a minority stake. “When valuing a minority stake, the position of the minority shareholder is very important,” says Guido Rooijackers, a partner at Sman Business Value.
"Investors often prefer a minority stake, but still want to be able to exert influence within a business. That’s why such investors often come up with a tightly drafted shareholders’ agreement, so they have a greater say in the business’s affairs. So you can be a minority shareholder with a tremendous amount of power.”
What role does control play in a minority interest?
In the study “The Valuation of Minority Shareholdings” by Ron Sman, founder of Sman Business Value, three types of minority positions are identified: the deliberately chosen position, the 50% shareholder position, and the passively acquired position. The deliberately chosen minority position typically involves careful consideration of the shareholder’s position in advance. This category includes investors, as well as joint ventures, family-owned businesses, and management buy-ins.
A 50% ownership stake is unique because two shareholders hold the entire controlling interest. In this situation, both shareholders must be able to get along well, otherwise disagreements will arise. Often, this discord leads to a conflict, requiring one of the shareholders to sell their 50 percent stake to resolve the issue. This passive position may sound like a precarious situation, but people often end up in this category through no fault of their own.
Consider an employee who receives a stock interest as part of their compensation package, or someone who inherits a percentage of shares. “When valuing a minority stake, you must first determine the individual’s position within the overall spectrum of shareholders,” says Rooijackers. “You also need to assess the degree of control associated with the shareholding, as that can vary greatly. From there, you apply discounts to calculate the economic value of a minority interest.”
What is a minority discount?
These discounts - or as register valuators call them: markdowns - involve a few things. To understand the position of the minority stock, the type of shares, the controlling position of the shareholder and factors affecting the marketability (saleability) of the minority stock must be considered. If a minority shareholder holds a 20 percent shareholding made up of common shares with little control and therefore difficult to transfer, he is not in a strong position.
This lack of control and lack of marketability result in discounts on the economic value of his shareholding. These discounts therefore mean that his minority interest is worth less than the pro-rata value of the shareholding. “Often, the limited control associated with a minority interest has a major impact on the bottom-line result,” explains Van der Noll, who also serves as an examiner for the Dutch Institute for Registered Valuators (NIRV).
"Research shows that discounts range from 25 to 90 percent, citing court cases in which the value of the stake was central to the proceedings. Such a discount has a massive impact on the value. But valuing a minority stake remains one of the most challenging topics in the world of valuation.'
Frequently Asked Questions
Is 25 percent of the shares also worth 25 percent of the company’s value?
Not necessarily. The shareholder’s position, their voting rights, and the marketability of the stake all play a role in determining what a minority interest is actually worth.
What types of minority shareholders are there?
Consider an MBI investor who is gradually buying into the company, an investment firm providing capital, an employee receiving shares as compensation, or family members acquiring a stake through inheritance.
What is a minority discount?
A discount on the pro rata value of a block of shares, applied due to the lack of control and lack of marketability of the minority interest.
How high can a minority discount be?
Research shows discounts ranging from 25 to 90 percent, based in part on court cases in which the value of a minority interest was a central issue.
Why can a minority shareholder still wield a lot of power?
Investors often negotiate a tightly drafted shareholders’ agreement in which they secure significant control rights despite holding a minority stake.
