Business Valuation Basics: Control and Minority Ownership

David L. Perkins, Jr.

Control of a company refers to the ability to "control" the operations and activities of the business. Control allows the controlling person, entity or group to influence or dictate who manages the business, how the company is managed, what the company does and where it operates, compensation levels, whether profits are distributed to shareholders or retained in the company, what investments are made, how the business is capitalized (borrow via debt or equity), and whether and when the business may be sold. As you can see, control is an incredibly important and powerful quality of ownership. Conversely, lack of control is a materially impaired position indeed.

So, What Dictates Who Controls a Business?
Generally, control is associated with an ownership percentage that exceeds 50 percent. This is because the controlling shareholder can win votes that require majority. Keep in mind, however, that the matter of a controlling or non-controlling ownership position is not an either/or proposition. It is rather a matter of degree. Things that commonly tip the balance one way or the other are:

- A company’s organizational documents, such as the articles of incorporation and bylaws.
- Statutes (laws) in the state of organization of your business, such as super majority voting requirements and what are known as "dissolution statutes."
- Distribution of equity ownership.

Distribution of Equity Ownership
The distribution of the ownership of the equity of your business can significantly influence the control and the value of a minority ownership position. For example, if there are only two equity holders, one with 66 percent and one with 33 percent, then the 33 percent holder typically will have almost no control. However, if there are three owners with equal ownership, each 33 percent shareholder can provide effective control for another of the shareholders, giving control to the two if they work together. This position in itself lends power to the minority. In turn, none of the shareholders has ultimate control thus their shares would not command a premium price unless paired with the shares of another.

The State of Your Organization Impacts Control Issues, Premiums and Discounts
State statutes affecting non-controlling shareholders’ rights vary from state to state. For example, some stipulate that a simple majority can approve major actions such as the sale of the business. Other states require a two-thirds or greater majority to approve such actions. This means that a non-controlling interest of just over one-third has the power to block many corporate actions. This characteristic adds to the power of the minority share, detracts from that of the majority, and improves the relative value characteristics. States also vary in the power they provide to minority stockholders that dispute value received in the sale of their business, and in the power they provide minority stockholders to force a buyout of their shares.

How Does Control Affect The Value Or Valuation Ownership Interests?
Control interests will sell for higher values than non-control positions, leading to what is referred to as control premiums or their counterpart, minority discounts. Studies have documented lack-of-control discounts averaging 25 percent to 30 percent for publicly traded companies. Similarly, premiums for companies that are going from lack-of-control to control positions are in the 35 percent to 45 percent range. The discounts and premiums for privately held companies and shares are usually much larger.

Discount or Premium from What Basis?
Control discounts and premiums are commonly misunderstood and commonly misapplied. When a private company sells in its entirety, it typically sells 100 percent and the price that is paid is for full control. Let's say a company sold for $1 million and had a single shareholder, so all the money went to the sole owner. No premium is considered to have been paid; rather the price paid was simply the value of the business. If we say that a similar company has two shareholders, split 66 percent and 33 percent respectively, and the minority shareholder wished to sell, then what would his or her 33 percentage be worth? One could argue that a 33 percent stake should be worth $333,333, but finding someone to pay such a price for a non-control position would be improbable. What would the fair market value be? Somewhere between $0 and $333,333, depending on the particular characteristics. Control premiums really don't occur except when a public company is purchased and a premium is paid over the share price at which individual non-control shares are traded on the open market (i.e. an exchange, like the New York Stock Exchange).

This article was written by David L. Perkins, Jr., founding partner of Vercor and manager of the Tulsa, Oklahoma office of Vercor.