Company valuation: the difference between control premium and minority discount

There is a theoretical and mathematical principle that allows to adjust the valuation of a company according to the quality of the shares held in a company.  

This principle explains that the market value of a security is not the same if this security allows to be a majority or minority shareholder in a company.  

It is therefore important to know the difference between a control premium and a minority discount. 

What is the control premium?

By definition, the control premium is the additional cost that a buyer/investor is willing to pay in order to obtain majority control of a company.  

The control premium thus represents the excess of the price spent to buy back the shares and the market value of these shares. This term is often used in the context of a takeover bid.  

It is therefore a process during which a buyer will offer to purchase all the capital of a company held by its shareholders at a price paid in cash. This notion of control premium is also found in the context of a financial valuation of a company.  

It can be understood by means of three main formulas:  

• the market multiples method; 
• the comparable transactions method ; 
• the Discounted Cash Flow model. 

This control premium must therefore be considered on the current market as an increase in the value of a share on the market. It therefore represents the value of the decision-making power conferred on the majority shareholder.  

Furthermore, some studies show that the control premium can vary between 20 and 30% depending on the transactional context, which includes the combination of several elements: 

• the rapprochement between the target and the acquirer ; 
• the proportion of competition between purchasers; 
• the economic sector; 
• the participation of the majority shareholder ;  
• the amount of synergy desired by the purchaser; 
• etc.   

Control premium: what does majority control of a company bring? 

Generally motivated by the advantages of majority control of a company, the acquirer bearing a control premium grants himself the following benefits: 

• the direction of the company's strategy: the decisions of the acquirer with majority control will weigh more heavily than those of the minority shareholders when it comes to strategic decisions related to the development and growth of the company; 
• hold seats on the Board of Directors ; 
• access the various cash flows generated by the target. 

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What is a minority discount in the context of a business valuation? 

In the world of finance, the minority discount refers to the discount that minority shareholders of a company take in order to be able to recover the equivalent of the amount of their stake in cash.  

It is particularly applicable to unlisted companies where the agreement of the majority shareholders is generally necessary in order to develop an effective corporate strategy. It therefore makes it possible to mark the difference in valuation between the minority and majority shareholdings.  

In the case of a listed company, we would talk more about an illiquidity discount.  

This corresponds to the valuation differential between an unlisted company and a comparable listed company with liquid securities. 

Thus, in the case where the stock confers a majority, a control premium would have to be added, whereas in the opposite case, there would be a minority discount. 

It's easy to see that being a minority shareholder in a company offers far fewer advantages than being a majority shareholder. This principle must therefore be taken into account when analyzing the value of a company. This implies : 

• not having control over the company's financial flows; 
• not to have a say in strategic choices and in the decision to distribute dividends; 
• to have difficulties in influencing operational management; 
• to know some limitations regarding access to strategic information. 

It would therefore be logical to think that this minority discount does exist. But what is it really like in the accounting stock? 

Does the minority discount really exist? 

Determining whether or not this minority discount actually exists is central to a business valuation. business valuation. 

The idea of a minority discount is based on the principle that a majority shareholder will put his personal interests before those of his other partners. Implicit in the idea is that the minority shareholder will benefit little or nothing from the company's cash flow. 

However, this is denied by the financial markets authority. Indeed, according to it, the majority shareholder will always try to maximize the profitability of his company's capital. And it is in his interest to do so, since he will himself benefit from the good functioning of the company! 

The minority shareholder, even if he has little power, also ends up benefiting from this management, to the extent of his shareholding in the company. 

However, there is a minority discount applied. For a publicly traded asset, the illiquidity discount is already built into the price offered by the market.  

To become a majority shareholder, you must pay a premium.  

Negotiations are mostly done outside the market. The majority premium (which is not systematic) is in this case also integrated directly into the price. 

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Business valuation: what does the law say about haircut issues?

The law sets a strict framework around the principle of equal treatment of partners. This theoretically prevents the minority discount. However, exceptions are provided for, for example if : 

• The majority shareholder has a conflict of interest with his other activities; 
• If the securities do not carry voting rights ; 

• If the shares are illiquid. 

The law therefore proposes to correct these inequalities by proposing a minority discount as a solution. It is necessary to look at the functioning of companies on a case-by-case basis. But it should be noted that this system of discount is in fact almost systematic when a minority shareholding is acquired in an illiquid company, such as an SME for example. This makes it even more complex to determine the value of a company when it is not listed. 

Conversely, minority shares that would offer more power than usual are given premiums. 

The jurisprudence does not wish to get locked into complex mathematical calculations. It applies an approach based on the weighting of the different methods.  

The Direction Générale des Impôts (DGI) proposes the following mathematical calculation for the valuation of minority shares in a company: 

• (Two asset values plus one profitability value) / 3 for a majority equity investment ; 
• (Two asset values plus two profitability values) / 3 for a minority equity investment. 

As a result, case law proposes minority discounts ranging from 15 to 30% depending on the case, with the average being around 20% for the valuation of "minority" shares in a company. 

Have your company evaluated:

Determining the different premiums and discounts is a complex exercise that requires taking into account the different characteristics of the companies as well as the potential power relationships between the shareholders.

The same applies to the study of control premiums, minority discounts and illiquidity discounts, which can often be cumulative.

As all these topics are usually the subject of long and difficult discussions in the context of negotiations for a transaction or with the tax authorities, the XVAL experts experts allow you to benefit from a professional approach with a reasoning built and argued. 

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