Lack of Control and Marketability
DLOC and DLOM Issues affecting valuation
When compared with the value of a majority interest in a public company, the value of a minority interest in a privately held company may be negatively impacted by marketability, liquidity and control issues.
Marketability is defined in the International Glossary of Business Valuation Terms as “the ability to quickly convert property to cash at minimal cost”. A Discount for Lack of Marketability (DLOM) is “an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability".
Given two identical business interests, a higher price will generally be paid by investors in the market for the business interest that can be converted to cash most rapidly, without risk of loss in value. An example is a publicly-traded stock on the New York Stock Exchange, where the owner can order the sale and the proceeds are deposited in a bank account in three days or less.
In the alternative, a lesser price is expected for the business interest that cannot be quickly sold and converted to cash. A primary concern driving this price reduction is that, over the uncertain time frame required to complete the sale, the final sale price becomes less certain and with it a decline in value is quite possible. Accordingly, a prudent buyer would want a discount for acquiring such an interest to protect against value loss in a future sale scenario.
The Business Valuation Committee of the American Society of Appraisers states a discount for lack of control represents “an amount or percentage deducted from a pro-rata share of the value of 100 percent of an equity interest in a business, to reflect the absence of some or all of the powers of control.” The discount for lack of control is synonymous with the minority interest discount. As cited in the third edition of Valuing a Business, by Pratt, Reilly and Schweis: The lack of control (minority interest) discount is attributable to the fact that a holder of a Member Interest generally does not have the power to:
- Appoint or change operational management or members of the board of directors
- Determine management compensation and perquisites
- Set operational and strategic policy and change the course of business
- Acquire, lease, or liquidate assets, including plant property and equipment
- Select suppliers, vendors, and subcontractors with whom to do business and award contracts
- Negotiate and consummate mergers and acquisitions, select joint venturers, and enter into joint venture and partnership agreements
- Liquidate, dissolve, sell out, or recapitalize the company
- Sell or acquire treasury shares
- Register the company’s equity or debt securities for initial or secondary public offering
- Declare and pay cash and/or stock dividends
- Change the articles of incorporation or bylaws
- Set one’s own compensation (and perquisites) and the compensation (and perquisites) of related-party employee
- Decide what products and/or services to offer and how to price those products/services
- Decide which customer categories to market to and which not to market to
- Enter into inbound and outbound license or sharing agreements regarding intellectual properties
- Block any or all of the above actions
How a minority interest valuation differs from the valuation of 100% of the business
Because the stock of many businesses are owned by individuals, the value of a majority or minority interest in the entity can affected by a number of variable. Among other variables that affect the partnerships value are: size of the interest being appraised, restrictions laid out in the family limited partnership or LLC operating agreement, the historical dividends paid (and expected future dividend paying capacity of the entity), the historical profitability of the partnership, the future outlook of the enterprise, the tax basis and net asset value of the underlying assets, etc.
Cambridge Partners appraises fractional ownership interests and partnership interests for a variety of purposes, including: trust and estate planning, IRS Form 706 returns, gifting, divorce, for buy/sell agreements, joint venture contribution, calculation of the minority interest for rollover equity, etc.