What is a minority stake worth?

In SMEs, minority interests are a regular occurrence. For example, when bringing an investor on board or during a partial takeover. But how do you value such a minority stake? 'This is one of the trickiest topics in valuation land.'

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.

'Many entrepreneurs think that forty percent of the shares equals forty percent of the total company value, but it doesn't always work that way,' says Frank van der Noll, partner at Berghout + MAS Accountants & Advisers. 'Among other things, you still have to take into account the position of the minority shareholder, what control rights are associated with that share package, how marketable the minority package is and what kind of shares are involved.'

Type of minority shareholder

There are several ways in which someone "gets" a minority stake. An MBI who buys into a company and gradually takes over often starts with a minority of the shares. Or an investment company that provides a capital injection to a startup negotiates a minority stake because the entrepreneur has to pull the cart. But also consider an employee who gets a pick of shares as a reward. Or a family business that spreads the equity stake out over the entire family, creating all sorts of "small" shareholders.

Now imagine that each of these types of shareholders (MBI'er, investment company, employee and family member) owns the same 25 percent equity stake in the same SME business. Then the expectation would seem to be that everyone owns a share package of the same value, but therein lies the crux of valuing a minority share. "When valuing a minority share, the position of the minority shareholder is very important," says Guido Rooijackers, partner at Sman Business Value.

'An investor often prefers a minority stake, but wants to be able to exercise influence within a business. That is why such a lender often comes up with a densely worded shareholder agreement, so that they have more say. So you can be a minority shareholder with an enormous amount of power.

Control

The study "The Valuation of Minority Positions" by Ron Sman, founder of Sman Business Value, addresses three types of minority positions: the consciously chosen position, the 50% shareholder position and the idle position. As a rule, the consciously chosen minority position has thought carefully about its position as a shareholder beforehand. This category includes investors as well as joint ventures (partnerships), family businesses and management buy-ins.

The 50% shareholder position is special because two shareholders represent the entire control. In this situation, both shareholders need to get along well, otherwise disagreement will arise. Often this discord leads to a conflict, necessitating the sale of 50 percent of one of the shareholders' shares to solve the problem. The idle position sounds like a plight, but often people end up in this category through no fault of their own.

Think of the employee who gets a shareholding as a remuneration component or someone who receives a percentage of shares through inheritance. 'When valuing a minority share, you must first determine what position someone holds in the total spectrum of shareholders,' Rooijackers said. 'In addition, you look at what degree of control is associated with the share package, because that can vary enormously. From there you start calculating discounts to arrive at the economic value of a minority interest.'

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 cause discounts to the economic value of his shareholding. These discounts therefore cause his minority stake to be worth less than the proportionate value of the equity package. 'Often the limited control in a minority interest has a major impact on the outcome at the bottom of the line,' explains Van der Noll, who is also active as an examiner for the Netherlands Institute of Chartered Valuators (NIRV).

'Research shows that discounts vary between 25 and 90 percent, referring to court cases in which the value of the stake was central. Such a discount has a huge impact on value. But valuing a minority stake remains one of the trickiest topics in valuation land.'