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Published January 28, 2013

Business Valuation Discounts for Minority Interests

In determining the value of a business, the existence and level of valuation adjustments is widely debated, and can have a substantial impact on the valuation conclusion.  The most common valuation adjustments include the discounts for lack of control (“DLOC”) and discounts for lack of marketability (“DLOM”).  Whether or not investors are capable of controlling business decisions greatly impacts the value of their ownership interest.  It is therefore common to place discounts on valuations for a lack of control, whether due to ownership of a minority share or a lack of voting rights.  Discounts must also be applied in order to take into account potential difficulty in exchanging the business for cash.  The liquidity and marketability of the investment affects its value due to the time and difficulty that may surround a potential sale transaction.

Minority ownership interests and non-voting shares must be discounted in order to take into account the lack of input in business decisions that affect the cash flow estimates, or assets used in the valuation of the business.  Because adjustments to account for lack of liquidity and/or control can have enormous implications on the value conclusion, it is critically important to understand the characteristics of the indication of value determined under the various valuation methods (asset, income, and market-based valuation approaches) utilized before applying such a discount. Furthermore, the valuator must understand the business’ operations and the extent of rights afforded to the minority shareholders. DLOC’s are quantified by analyzing the level of premiums paid by investors for controlling ownership interests in business enterprises relative to minority interests in the entities.

When valuing minority interests, the valuator must also consider the difference in the marketability of an investment in the subject entity and shares of publicly traded companies. Generally, these minority interests in closely held companies are considered illiquid relative to most other investments.  For purposes of determining a DLOM adjustment, it is necessary to research and analyze multiple studies and resources, including benchmark, securities-based, and analytical approaches.  Additional information on methodology and information considered in the formulation of DLOM’s can be reviewed in more detail in the IRS Job Aid on Discounts for Lack of Marketability.

Overall, discounts taken on minority interests in closely held companies lower the valuation indication of the business. This decrease in value is associated with the uncertainty associated with a lack of control of the business’ operations and in the reduced ability to sell/transfer an ownership interest in the company.  In order to determine if valuation discounts are appropriate, and/or to what degree, the valuator must consider the specific circumstances of the business being appraised.

If you have any questions about PYA’s business valuation services, please contact the experts listed below at (800) 270-9269.

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