We have often had to address the issue of minority interests when valuing businesses in litigation matters and business restructuring. A minority interest is one where the interest does not have control of the entity being valued, i.e. the shareholding is less than 50%.
It is generally recognised that a discount needs to be made when the interest being valued is a minority interest. That discount is a measure of the reduced value of the shareholding due to a lack of negotiability and the lack of control that the shareholding has.
Minority shareholders in a private company are effectively at the mercy of the controlling shareholders in respect of not only their annual dividend income, but also the flow-on effect of dividend policy to share value. Minority shareholders are restricted in their ability to sell shares or it may be that there is no market for the shares at all.
Minority shareholders may not have rights to a significant input to the decision making process of the management of the business or the dividend policies of the company. Whilst minority shareholders do have rights, these may need to be defined through the courts and can be both costly and time consuming.
There is little empirical evidence as to the level of discount for minority interests in the marketplace. Takeover premiums of publicly listed companies are often used as a base for measuring the discount for minority interests, however, minority interests in public companies have much greater protection than private companies and public companies have a greater pressure from the market to perform and declare dividends.
The question arises as to whether the minority interest discount as it is assumed to apply to publicly listed companies should also apply to:
- Unit Trusts where the unit holders are presently entitled to the income of the trust and not dependent upon the board of directors o declare a dividend.
- Professional partnerships where control is diluted between the various partners, i.e. no one partner has control of the business and control is shared.
- Single purpose trusts such as property trusts where the only asset of the trust is a property and the income is passive (rental income).
- Private companies that do not have a history of paying dividends.
Given the lack of practical evidence in respect of the level of discount applied in the marketplace, it is often necessary to view each valuation on its merits and on the particular circumstances of that entity. It is necessary for the valuer to look at:
(a) The history of the entity;
(b) The entity’s constitution;
(c) Any shareholder ort partnership agreements;
(d) The nature of decision making within the entity; and
(e) The historical payment of dividends and distributions.