We have been getting frequent questions about discounting minority interest in insurance agencies. It is a very confusing topic but it need not be.
First, a definition: Minority Interest represents an ownership stake of less than 50% of a company. Minority Discounting is the reduction applied to the value of a minority equity position in a company DUE TO THE ABSENCE OF CONTROL. Minority shareholders are generally unable to elect directors, to determine the future strategic direction of the Company, the determine the timing of their return on investment and are unable to fully control the sale of their own shares. This absence of control reduces the value of their minority interest against the total value of the Company.
Minority discounts are particularly common in the valuation of closely held companies (like insurance agencies) with a small number of owners (like insurance agencies).
MOST IMPORTANTLY, MINORITY DISCOUNTS ARE ONLY APPLIED AND ARE MEANINGFUL IN THE SALE AND PURCHASE OF MINORITY INTERESTS IN A COMPANY. IT DOES NOT APPLY TO 100% SALES OF A BUSINESS. IT DOES NOT APPLY WHEN THE SHAREHOLDERS ARE VALUING A BUSINESS WITHOUT THE SALE OR TRANSFER OF STOCK OWNERSHIP.
In the simplest example, if a Company was worth $1,000,000 and had a 80% owner and a 20% owner, an outside investor would not pay the minority owner $200,000 for his interest in the Company because of a lack of control attached to his minority shareholding even though he owns 20% of a $1,000,000 value Company. This, of course, assumes that the valuation of the Company is based on the value of ALL of its stock and/or assets. That Fair Market Value is valid as the value of the entire company or as the relative value of the controlling interest in the Company.
So, keeping this simple, if we value an agency at $1,000,000 (the value at which a buyer would purchase the entire company – not just its revenue or income base) it presupposes that a transaction would be for either the entire company or for at least the majority controlling interest in the Company. Logically, if a minority owner were selling his/her stock, a minority discount would apply for the reason cited above, a lack of control or marketability. It is less desirable to purchase a minority interest in a company than a majority interest.
What minority discount is applied and when? The answer is, IT DEPENDS!!.
Historically, the premiums paid for controlling interest in public companies have ranged from 25% to 50% based on a number of variables:
- The size of the share of stock in question – there is still a lack of control and marketability to a 49% owner vs his 51% partner. But, if the 49% owner has several or many 5% or 10% owners, the discount disappears because the 49% shareholder has virtual control with any one other owner.
- The relationship between the shareholders – if a family or group of stockholders combines to control the Company, little or no discount would be applied to the sale of the interest of members of that group.
- Provisions of the Shareholders Agreement – the combined protection of the interests of the minority shareholder found in a Shareholders Agreement diminishes any minority discount accordingly. For instance, if the Company guarantees the re-purchase of stock or the value of stock or makes it difficult to eliminate any stockholder, the discount, if any, diminishes in accordance with the level of protection afforded the minority shareholders.
- Past sale of stock – if prior minority shareholders were given full value for their stock, it sets precedence for the future sale of stock with respect to discounting.
- Shareholder involvement in the business – the more involved a shareholder is in the operation and/or management of the business (i.e. Board membership), the lower the discount for minority interest.
- Negotiated Motivation – The more motivated the seller is to sell, the higher the discount that can be applied by the buyer. The more motivated the buyer is to purchase the shares, the lower the discount that can be motivated by the seller. For instance, the death of a minority owner without a requirement for the agency (or the majority owner) to purchase the deceased owner’s stock, the higher the discount and lower the potential realized price to the estate of the deceased owner. On the other hand, if an existing owner wishes to purchase a minority interest in order to cement control of the Company, the less the discount likely to the price.
So, the amount of the Minority Discount depends on a variety of considerations and those considerations may be different depending on the conditions of the sale and purchase, the timing of the transaction and the relationships between owners, buyers and sellers.
People who hold minority shares in a company can still receive full value when a company is sold in total. When that happens controlling interest passes to the next owner or owners of the company and no minority interest discount is applied to the selling owners who happen to be minority shareholders.
So, when we value insurance agencies, we will typically value the entire Company without any consideration of minority shareholder’s discount. However, when we know that an acquisition or sale is being made of only a minority interest in the agency, a discount will be calculated considering the points reflected above as well as any other considerations that would increase or decrease the percentage discount that should apply to a minority purchase or sale.