Valuing a Company: The Difference Between Control and Non-Control

The differences between controlling interests and non-controlling interests are many and manifest themselves in ways that affect both the operations of the company and the valuation of the interests in question.

Consider This Scenario

business owner profile

The owner of the 60% interest would be able to control all aspects of the company’s operations.  She could appoint herself as the CEO, make strategic and tactical decisions, declare distributions, and maybe even force liquidation.  The owner of the 10% interest could do none of these things.  Any buyer of either interest would certainly understand these differences as well as the current owners.

Fair Market Value – Application of Discounts

The Fair Market Value standard requires business appraisers to consider hypothetical willing buyers and sellers both with full understandings of the facts surrounding the company and the interest in question, but neither with any compulsion to buy or sell.  So, in valuing the interests, a business appraiser must ask what the practical differences in percentage ownership would be and how those differences would affect value.  There is one school of thought that supports valuing the ownership interests the same way and applying a discount to reflect the absence of control associated with the 10% interest, as opposed to the 60% interest.  These discounts are generally based on market data derived from what are believed to be premiums for control evident in other transactions.

Control v. Non-Control Adjustments

Another school of thought supports considering the ownership interest in ways that reflect their actual control of the company.  In order to perform an analysis this way, it is important to understand exactly how the owner of the 60% interest could control the company in ways a 10% owner could not.  For instance, the buyer of the controlling interest would perceive the ability to change the company’s cash flows, perhaps by eliminating unnecessary or redundant expenses.  In addition, a controlling interest holder could change the capital structure of the company, potentially decreasing the company’s cost of capital.  Each of these adjustments could increase value, and together the increase would be compounded.  A buyer of the non-control interest would have no ability to change either the company’s cash flows or capital structure, and would be saddled with the company in its current situation, no matter what the current state. That is, the owner of the non-controlling interest could be stuck with a company that employs multiple members of the controlling owner’s family, all of whom are paid exorbitant salaries.  Analyzing a company on this basis, one would ignore the obvious change in cash flows available to a buyer of the controlling interest who could/would fire the offending family members.

Which Way is Better?

Adjusting cash flow and capital structure is a more supportable analysis because a business appraiser can make decisions based on the company’s actual operations and financial structure rather than depending upon discount data that may or may not be relevant to the specific company. Likewise, when considering a non-controlling interest, one should simply ignore those factors that a non-controlling owner could not change.  No matter which school of thought is subscribed to by an individual business appraiser, there are clear differences between controlling and non-controlling interests can have a significant impact on the values of the different interests.  Understanding the differences and the effects of those differences is the key to understanding value, and to producing a reasonable and supportable valuation.

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Daniel Kvarnberg

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