To Discount or Not to Discount – That is the Question
Minority Discounts - Part I
In this blog series, we will discuss minority discounts in the context of valuations and provide insight on factors that impact the quantum of the minority discount applied.
Time and time again, valuators are faced with the question of whether a minority discount should apply when valuing the shares of an owner that does not exercise control of a company. Does a shareholder’s 20 percent interest translate to 20 percent of the value of the business as a whole?
The answer is that it depends. The shares of a company can have different values depending on the standard/definition of value being applied.
The idea of applying a minority discount is to reflect that partial ownership may be worth less than its proportionate ownership in the entire business. Why? That’s because a non-controlling shareholder may not have the same privileges that a majority shareholder does. Such privileges may include the ability to elect a majority of the Board of Directors and therefore influence and manage the business, distribute dividends, set salaries and bonuses, and even initiate a sale or liquidation of the business.
In determining whether a minority discount is applied, a valuator must consider the context of the sale. If the sale is to a third party, it may be appropriate to apply a discount, as the purchaser understands that they will have no decision making power. However, when the shares are being acquired by those who already hold the majority, it may be inappropriate to apply a discount. The rationale is that when a controlling shareholder purchases a minority shareholder’s interest, this gives the purchasing shareholder additional control, and therefore there is no reason to discount the minority interest.
If on the other hand, the sale of a business in not imminent (i.e. notional valuation) or when future oppression is purely speculative, Courts may be more hesitant to apply a minority discount.
The Family Law Act
The Family Law Act in Ontario does not define the term “Value”. For family law purposes, ‘Fair market value’ is generally accepted by the Courts as “Value”. However, fair market value may or may not be the most equitable standard of value to apply to a minority interest. Instead, other standards such as ‘fair value’ could be considered if the omission of a minority discount provides a fairer settlement.
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.
The process of determining whether a minority discount should apply is subjective as it is based on the interpretation of the facts that are specific to each circumstance. There is no hard or fast rule, or mathematical formula.
Stay tuned for our upcoming blog which will focus on specific factors that affect minority discounts.
If you would like a further discussion on minority discounts or your specific situation, please do not hesitate to call our team.