Discount for Lack of Control: What You Need to Know
When it comes to valuing shares in a company, the difference between majority and minority owners is quantified in the discount for lack of control. It recognizes the substantial difference in value when control is part of the equation. People value control a lot! In many companies, minority interests are not allowed to be sold or traded except under very strict circumstances or when the majority owner chooses to sell the entire company. The discount reflects this lock-in, which often lasts years or even decades.
What’s the difference between majority and minority owners?
Companies generally have two types of owners: majority, or control owners and minority owners. Owners impose their will upon companies in various ways from shareholder votes to board votes to management directives. The fact that an owner owns 51% (or even 100%!) brings one key difference.
The controlling owner can, at any moment, decide to sell all or part of the company and/or change everything. In most closely held companies there is usually nothing stopping the majority owner from selling the company at any time.
Most investors will insist on control consents which place restrictions on what owners can do without the investor's agreement, but companies without investors rarely have these kinds of restrictions. Minority investors in private companies have a completely different experience. They may pay for or earn their equity stake but since it’s small (under 50%), it brings little or no decision-making power in the company. Most of these minority owners can only vote their shares at an annual meeting but if the majority owners have them outvoted, it will matter little. Regardless of their desire to sell their shares, they simply have to wait until the majority owner is ready to sell.
They are along for the ride. Worthwhile, yes, but not as good as being in control.
How is the discount determined?
How large the discount is depends on many factors including the likely time frame to exit, the willingness of the majority owner to share control, and the level of alignment on the outcome. It's often in the range of 15-40% depending on the purpose of the valuation. This level of discount is high enough to derail many potential deals with people who are not aware of valuation methods or have rigid ideas about the value of their asset.
Another related discount that often takes people by surprise is the discount for lack of liquidity. That's a topic for another post, though! Talk to your investment banker, exit coach, or board to learn how these and other factors may impact your valuation.