Date of Award

1991

Document Type

Thesis

Degree Name

Master of Valuation Science

Department

Business

First Advisor

Arlene Taich

Second Advisor

J. Garry McAllister

Third Advisor

David Dorton

Abstract

According to the 1990 Statistical Abstract of the United States, approximately 17 million businesses exist in the U.S. They are comprised of over 3.4 million corporations, 1.7 million partnerships, and more than 12 million sole proprietorships. Furthermore, the United Shareholders Association reports that there are approximately 47 million minority shareholders in approximately 10,000 U.S. public companies. It is logical to infer from this data that millions of minority shareholders also exist in closely held companies - that is, non-publicly traded companies.

A minority interest is an interest which has no meaningful control over the day-to-day operations of a business, as in the case of a minority shareholder who owns less than 50.1 percent of a corporation and has no input as to management's salaries or other corporate matters, including the payment of dividends. In a public corporation, the minority shareholder with free-trading stock can simply sell his stock through the appropriate exchange and receive cash for his stock based on the bid price less commissions. Simply put, such a minority shareholder, while not having "control," does have "marketability." In a closely held situation, however, the minority shareholder often has little, if any, opportunity to attract a buyer to assume his position, which has neither control nor liquidity.

The following schematic illustrates the three basic levels of value. The example assumes a corporate structure with common stock; this valuation principle, however, applies to other business entities, such as partnerships, as well.

  • Top level - corporate control and marketable (liquid)
  • Middle level - lack of control but marketable (liquid)
  • Bottom level - lack of control and lack of marketability (not liquid)

As can be seen in the schematic, the non-marketable minority interest (bottom level) is worth much less than the marketable controlling interest level (top level) because of control and marketability differences. To determine the proper value for the minority interest, the higher levels of value must be discounted. Since we are examining the issue of a minority interest in a closely held corporation, the first discount to be taken is the "lack of control" discount. Accordingly, the second discount, known as "lack of marketability," would be taken from the already reduced value. If a controlling interest is being valued that lacks a public market, then only the "lack of marketability" discount would be applied.

Each minority interest valuation situation differs, requiring detailed analysis by a business valuation expert to determine the appropriate discount levels. Other premiums and discounts, exclusive of the discounts for lack of control and lack of marketability, are present in many minority interest situations. One discount that is often overlooked is the discount for lack of capability to be a public company, which applies to companies that could not reasonably go public. This discount is not accounted for in the "typical" lack of marketability discount, which is based on restricted stock studies of companies that are already public.

The business valuation expert must carefully examine the subject minority interest for other premiums and discounts. The expert must then quantify the other premiums/ discounts and correctly incorporate them in his/her valuation in order to correctly prepare a minority interest valuation.

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