What is a Minority Discount?
A minority discount is a concept used in the valuation of a company, which reflects the fact that minority shares in a company are worth less because their holders do not have a controlling interest in the company. Minority discounts come up particularly commonly in the valuation of closed companies with a small number of owners. In these situations, people with minority shares cannot control the company and thus lack the ability to shape the company or move it in new directions.
When a company is valued, one of the first steps is to determine the overall market value of the company as a whole. With this information in hand, the valuator can determine the value of individual shares in the company. In a case where partners split a business 60-20-20, one might expect a proportional value; that a person holding 20% of a company, in other words, would have shares worth 20 percent of the company's value. However, this is not the case, because that person has a minority interest.
In the example above, the valuator might decide to take a five percent deduction in value to reflect the minority discount. Someone who controls 20 percent of the company would in fact only hold 19 percent of the company's value. The amount of the minority discount is not set. It depends on a number of factors and is adjusted for a given situation, rather than being applied as a universal standard.
For people who hold minority shares in a company, the minority discount means that they cannot get as much for their shares as they would if they held a controlling interest. This can become a critical point in negotiations to sell or reorganize a company, as minority shareholders concerned about losing out because of the minority discount may be more resistant if they cannot negotiate a reasonable deal.
A related concept is the control premium, the amount over market value which someone would be willing to pay in order to buy a controlling share. In the example above, if one of the 20 percent partners bought 20 percent of the 60 percent partner's share, he or she might be willing to pay a control premium to acquire the 20 percent share from the other minority shareholder. The control premium reflects the substantial advantage someone holds when a controlling share in a company is obtained. Investors who are savvy about deal-making can strike a hard bargain with someone who is interested in acquiring a controlling share in a company and has substantial funds to support the attempt.
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