A discount applied to a non-controlling ownership interest in a small business.

The minority interest discount reflects the notion that a partial ownership interest may be worth less than its pro-rata (proportional) share of the total business. For example, ownership of a 30% share in the business may be worth less than 30% of the entire company value. This is so because this 30% ownership may be limited as to the scope of control over critical aspects of the business, including:

• Electing the company directors and appointing its officers.
• Declaring and distributing dividends.
• Entering into contractual relationships with customers and suppliers.
• Raising debt or equity capital for the company.
• Hiring and dismissing employees.
• Selling or acquiring assets.
• Selling the company, acquiring other operations.

The effect of applying a minority interest discount is to reduce the value of partial ownership interest below its proportional share of the business. As an example, discounting a 30% partnership interest by 20% would reduce its value to 24% of the overall business.

There are several commonly used ways to determine the value of a minority business ownership interest:

• As a pro-rata portion of the total business value minus a discount.
• In comparison to market data involving similar minority ownership interest transfers.
• As a present value of the economic benefits stream expected from ownership of the minority interest in the company.

While calculation of the pro-rata share of the business value is straightforward, determining the discount to be applied requires careful consideration. Comparative market data involving the sale of non-controlling ownership interest in closely held businesses is hard to find. However, there is plenty of pricing information available regarding public company stock sales, which can provide useful guidance.

A Discounted Cash Flow valuation can be applied directly to the stream of economic benefits that the owner of a non-controlling business interest can expect to receive. The economic benefits typically include dividends or partnership withdrawals taken over time and the share of proceeds from the business sale.

Valuing a Business based on Cash Flow and Risk