Minority Ownership Discount
A discount applied to a non-controlling ownership interest in a small business.
What It Means
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.
Control premium and minority ownership discount
Typical public company stock sales are transactions involving minority interests. On occasion, a controlling block of shares in a public company is acquired. The acquiror usually has to offer a premium to induce a large number of shareholders to sell their shares of company stock. Once you know the premium paid for a controlling stake in a business, you can calculate the minority discount from it.
Direct valuation of non-controlling ownership interest
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.