Factors Impacting Minority Discounts
Minority Discounts - Part II
In this blog series, we discuss minority discounts in the context of valuations and provide insight on factors that impact the quantum of the minority discount applied.
In a previous blog To Discount or Not to Discount – That is the Question, we introduced minority discounts in the context of valuations and provided high-level comments on when they may or may not apply. In this blog, we discuss specific factors that impact the quantum of the minority discount applied.
Factors Impacting Quantum of Minority Discount Applied
The level of the discount will depend on, but is not limited to, the following factors:
- Standard of value being applied will impact the value of the minority interest. The Family Law Act in Ontario does not define the term value. ‘Fair market value’ is most commonly used as it has generally been accepted by Courts. However, fair market value of a minority interest may be less or in some circumstances more than pro rata value. While the decision of the applicability and the quantum of a minority discount is ultimately up to the Courts, valuators may make recommendations in their reports regarding its application.
- Existing Shareholder agreements might restrict the transfer of shares, therefore increasing the discount or provide the minority with an increased measure of control over the operations, and thereby reducing the discount. A shareholder agreement can also require that, where shares are sold, they must be sold or at least offered to specific parties, such as other shareholders. The agreement may also stipulate how the price is determined in the event of triggering circumstances, and whether a minority discount will be applied. For example, it may specify that no discount should apply in the event of a death or disability of a shareholder, but in the event of negligence, default or voluntary departure, a punitive discount should apply.
- The size of the shareholding and its relative importance must be considered. Generally speaking, the greater the size of the minority shareholding, the lower the discount. Though that’s not always the case. For example, in Fitzpatrick v. Fitzpatrick, 2004 CanLII 13318 (ON SC), where Mr. Fitzpatrick only held 22% of the issued common shares, a minority discount was not applied. That was because there were five shareholders, none of whom held more than 22% of the issued shares, and so at least three of the five shareholders were required to make any majority decisions.
Additionally, minority shareholdings occasionally have “nuisance value” in cases where they can prevent a takeover bid, or cause delays related to corporate planning. However, nuisance value may be difficult to identify in the absence of an open market transaction.
- Provisions in the articles of incorporation and by-laws include specific rights such as dissent, appraisal and oppression remedies, and therefore protect the minority shareholder by valuing the shares without a consideration for a discount based on the “just and equitable principle”.
- Shareholder relationships. In the example of a minority shareholder who owns 40%, but the other shareholders, a husband and a wife each own 30%, the minority shareholder discount would increase as the husband and wife could act in concert and pass a special resolution.
- Dividends and distributions. Historic dividends indicate the minority shareholder’s return on investment as well as the potential for future dividends and the likelihood of capital appreciation which might lower the discount.
- Previous sales of shares in the corporation can set a precedent as to the appropriate discount to use.
In addition to the factors outlined above, in an open market transaction, the discount will predominantly depend on negotiation abilities. If a seller is motivated to sell, they may be willing to accept a higher discount, whereas if the purchaser is motivated to buy, the seller may be able to negotiate a lower discount.
How the Courts determine whether to allow for a minority discount, depends on the specific circumstances of each case. There has been wide discretion applied and therefore an expert’s opinion may be useful.
If you would like a further discussion on minority discounts or your specific situation, please do not hesitate to call our team.