The value of a minority shareholding: Lack of control and marketability can result in a discount

When starting a new business venture, shareholders generally put in their pro rata share of the initial capital stock. However, when they exit, they might not receive the pro rata amount of the fair market value of the equity, depending on the circumstances of their exit and other considerations explained below.

In a privately held company, a non-controlling shareholder does not have the power to make decisions regarding certain corporate actions such as paying out dividends, putting the business up for sale to a third-party buyer, making decisions about the strategic direction of the company, entering into contracts with specific customers or suppliers or determining executive compensation. This means that in valuing a minority shareholding, a discount for lack of control would generally be considered and, if applied, would reduce the pro rata value of the shares determined for the whole company on an en bloc basis.

In addition, a discount for lack of marketability of a minority shareholding in a private company may also be applicable by reason of its lesser marketability than a majority stake because there would generally be fewer potential buyers for a minority position. The private minority shareholding can also be contrasted with a minority position in public company shares which are freely tradable and thus fully marketable and liquid.

Therefore, when valuing a minority shareholding, the per-share amount of the fair market value of the equity of the business as a whole is discounted to reflect lack of control and lack of marketability (the discounts are sometimes combined and termed “minority discount”). Some of the factors considered include:

Relationships between shareholders: In general, if the other shareholders are family members, it is assumed their relationships are harmonious, and they would act in concert to maximize value to all shareholders (unless the facts are contrary). In this case, there would be little or no minority discount. Guidelines have emerged over the years from the Canadian income tax authorities in this regard.

Whether there is a unanimous shareholders’ agreement and the rights that it confers: For example, veto rights for certain corporate actions; put rights; a right of first refusal on the sale of the shares to a third party; any stipulation regarding the non-application of minority discounts. If the agreement provides liquidity for the shares and more rights for the minority shareholders, this will indicate a lower level of discount.

Whether there is a history of prior transactions in the shares: This would provide evidence of a market for the shares and whether any discounts were explicitly or implicitly applied.

Whether there is a history of dividends paid by the company: The payment of dividends provides a return to the shareholder, in contrast with a situation where no dividends are paid in which case the shareholder must wait for a liquidity event to crystallize any gains in the shares.

The prospects for a future liquidity event: For example, a potential sale of the entire company, in which case all shareholders would cash out based on their proportional holdings without any discounts.

The relevant corporate law: The various provincial and federal Business Corporations Acts may provide for dissent rights and oppression remedies for minority shareholders under specific circumstances.

The size of the shareholding and its importance relative to others: A larger minority shareholding may have greater value if it has the ability to block certain corporate resolutions under the applicable law by virtue of which the company is incorporated (e.g., over 25 percent or 33 1/3 percent). A 25 percent shareholding with a seat on the board of directors would likely have a lesser discount than a two percent shareholding without an active role in the company. Interestingly, two 50 percent shareholdings would both be non-controlling interests and minority discounts may be applicable.

The quantum of the discount will depend on these considerations and will be based on the valuator’s professional judgement and experience. Minority discounts can range from nil to 50 percent or higher, depending on the facts and circumstances specific to each case.

Contact:

Catherine Tremblay, Leader, Business Valuation and Litigation Support, Québec-Ontario region, at 514.228.7772 or [email protected]