Business Valuation Discounts and their Applications

A valuation discount is a difference in value between a company’s peers in the same industry that a buyer assesses.

The capacity to transfer non-controlling interests in a corporation is one factor to examine. Because of their lack of control and marketability, these interests may be exposed to discounts, lowering the overall value conveyed through a strategy. You might be able to dump a larger amount of a company’s ownership while still keeping a large portion of the gift and estate lifetime exemption. When considering an appraisal engagement, there are two sorts of firms to consider: an operational company that is in business primarily to profit from the sale of a product or service, and a holding company that is in business primarily to profit from the holding of assets for investment purposes.

Valuation discounts and their applications

An appraiser will often evaluate four sorts of discounts when valuing holding companies: a liquidation discount, a discount for lack of control, a discount for lack of marketability, and a discount for co-tenancy (which is also referred to as a discount for an undivided interest in real estate). Unless otherwise stated in the following discussion, the authors have assumed that the valuation discounts mentioned above are for the purposes of appraising a holding company rather than an operating firm.

What are valuation discounts?

A valuation discount is a difference in value between a company’s peers in the same industry that a buyer assesses. Prior to executing a purchase, buyers would often evaluate comparable transactions as part of their due diligence. This analysis presents a set of multiples that are commonly used in most transactions. If the buyer is willing to pay less than or equal to the low end of this range, the target company has undesirable characteristics that justify a markdown in valuation.

How do valuation discounts work in the business valuation process?

Transactions between buyers and sellers determine the fair market value of a company’s investment. Under commonly accepted valuation procedures and methodologies, the ultimate calculation of fair market value needs the company valuator to identify and consider those ownership interest characteristics that are distinctive to the interest being valued. Investors are wary about taking risks. Ownership interest characteristics that raise the risk of holding the investment reduce the value of the ownership interest naturally. Those exact traits that tend to reduce investment risk will also raise the value of that ownership stake. The appropriateness of any discount or premium cannot be determined until the base against which the adjustments are made is defined.

Discounts and premiums cannot generate a correct outcome if they are applied to an incorrect base value conclusion. There are no “specified” discount or premium levels or ranges from which the evaluator can determine the appropriate changes for an individual situation.

Furthermore, the evaluator cannot expect to utilize the same set of computations or formulas in jobs with different facts and situations to identify the relevant changes. The discount for lack of ownership control (minority) and the discount for lack of marketability is widely believed to be unique and distinct ideas, but they are not mutually exclusive.

Metrics that influence valuation discounts in business valuation

There are numerous metrics that influence business valuation discounts, which are listed below:

  • Purpose of the valuation – Is the valuation for divorce purposes, estate, ESOP, etc.
  • Valuation of ancillary rights and attributes of a certain ownership stake.
  • Put options or transfer restrictions.
  • The voting vs. non voting share structure of the company being appraised.
  • Management team quality – inexperienced management, bad family connections
  • Company size – The size of the company, whether it is small business or a massive multifunctional enterprise, determines the valuation discounts.
  • Consideration of the size of the stock block being valued – swing vote.
    Appropriateness of managerial wages, perquisites, and other benefits – excessive pay and/or benefits.
  • A minority shareholder’s control.
  • Stock-related concerns include dividend policy and history, stock redemption policies, and stock-related limitations. Right of first refusal, sales, and so on.
  • The subject company’s financial state and earnings volatility – bank dividend limits, etc.
  • Federal and state regulatory constraints – Treasury controls on estates and gifts; Department of Labor laws on employee stock ownership plans, State corporation statutes – supermajority in New York/Illinois.
  • Desirability of the market – struggling vs. booming industries.
  • Potential synergies with a potential acquirer, if any
  • Time horizon for investment
  • Entities that pass through

Valuation Discounts

When a company is valued, it is generally assessed on its ability to create future cash flows, with the present value of those cash flows determining its worth to investors. However, in the actual world, such exercises do not provide a realistic representation of a company’s worth on its own. There are situational and contextual aspects of a transaction that aren’t accounted for in the financial statements and must be accounted for.

Types of valuation discounts

Lack of marketability, lack of control, minority stake, and future interest discounts. Depending on numerous criteria, these savings can range from 10% to 45 percent depending on numerous criteria.

Discount for Lack of control

A discount for lack of control is a decrease in the value of a firm’s stock as a result of a shareholder’s inability to exercise control over the company. Because corporate choices like establishing remuneration, defining policies, deciding to sell or liquidate, and declaring dividends are all out of the shareholders’ hands, this is nearly always deemed to be worth less than a controlling interest in a company. As a result, a discount for lack of control is frequently imposed when non-controlling or non-voting shares are valued for a private corporation.

Discount for lack of marketability

The approach used to evaluate the value of closely held and restricted shares is known as discounts for lack of marketability (DLOM). The assumption behind DLOM is that there is a valuation discount between a publicly listed stock, which has a market, and a privately owned stock, which frequently has little or no market.

The limited stock approach, the IPO method, and the option pricing method have all been used to quantify the discount that can be applied. According to the restricted stock technique, the only difference between a company’s common stock and its restricted stock is the restricted stock’s lack of marketability.

As a result of this lack of marketability, the price difference between the two units should arise. The IPO approach is based on the price differential between pre-IPO and post-IPO shares. The DLOM is calculated using this method as the percent difference between the two prices. The price of the option and the strike price of the option are the determinants of the DLOM in the option pricing approach. The DLOM is calculated using the option price as a percentage of the strike price.

Liquidation discount

In finance and economics, liquidation is the process of closing a firm and allocating its assets to claimants. The term “liquidation” can also refer to the sale of non-performing items at a lower price than the cost to the company or the price that the company wishes. It is a common occurrence when a firm is insolvent, meaning it is unable to meet its commitments when they are due.

When a company’s operations come to an end, the leftover assets are used to pay creditors and shareholders in order of precedence. Liquidation is a possibility for general partners. Liquidation discount refers to the sale of non-performing items at a lower price than the cost to the company or the price that the company wishes.

Co-tenancy discount

A co-tenancy discount is available when the appraised equity interest holds an undivided interest in real estate. Because there are so many factors to consider while evaluating this discount, the authors will not go into extensive length about it in this paper. Rather, the authors want to emphasize that this discount involves studies comparable to those performed for the other discounts previously outlined, with the exception that it only applies to an undivided stake in real estate.

Application of all valuation discounts

Discounts or premiums may be given to the calculated value of interest or operational business to reflect the lack of liquidity and ownership rights or constraints, depending on the type of interest or subject entity, degree of value, and assumptions used in developing cash flows.

  • Prior to the Cotenancy Discount, the Net Asset Value was (-) Discount for tenancy (a percent off a specific real estate asset)
  • Net Asset Value (NAV): (-) Discount for liquidation (either an actual cost amount or a percent of Net Asset Value)
  • The Worth of a 100% Controlling, Marketable Interest (-) Reduced price due to a lack of control (a percent of the Controlling, Marketable Interest Value)
  • A 100 percent noncontrolling, marketable interest is worth a lot of money.
  • (-) Price reduction due to lack of marketability (a percent of the Noncontrolling, Marketable Interest Value) = The value of a noncontrolling, nonmarketable interest that is 100 percent non controlling.
  • If any of the foregoing discounts do not apply to the assessed equity stake, they can be discarded, but the order of the remaining discounts should stay the same.

Holding corporations are eligible for a number of different discounts. In order to apply the proper discounts and generate a credible estimate of value for a firm, the appraiser must have a complete grasp of the organization, its purpose, and operational structure, as well as the equity rights allocated to its interest holders.

How can you make valuation discounts less complex?

The value of a pure holding company with no running assets trades at a significant discount to its AV. This discount can be moved in some situations and failed at a premium in others, based on the following:

  • Future exceptions – Increases when the market anticipates the holding company to consolidate. In these circumstances, the holding company only values north of its discount set, and the lower side is the holding company. This is because holding subsidies may exist only single entities with direct control of M&A said also holding companies that are expected to sell it state in other companies and other investments discounters the value of the holding company investments are realized and the expectation of dividend by the stake share older increases.
  • Dividend with subsidiary – It is commonly observed that holding companies that switch receive a dividend from their subsidy at a smaller discount than those that do not receive a dividend. This is because a pure holdings company’s primary source of income is the dividends collected from its subsidiaries. Because the holding company is exempt from dividend distribution tax, the dividends received from the subsidies will not be paid to the shareholders.
  • Types of investments – If a holding company’s investment includes a controlling share in other companies, the holding company’s NAV will increase by 40 to 60 percent. It is typically sold at a reduced discount. This is due to the holding company’s amount of control over its subsidy and sales, shown in its consolidated financial statements.
  • Expert team of valuation providers – A business valuation specialist’s job is to figure out how much a business or corporation is worth. They create a complete report that can be used in a business sale, litigation, divorce, or determining partner ownership. The experts examine the company’s financial, strategic, and operational aspects before performing a valuation geared to a certain purpose, usage, and reporting requirement.

Why should you choose Eqvista for your business valuation services?

As a business owner plans for future growth and eventual transfer, an accurate valuation of a closely held business is crucial for assessing potential and opportunity costs. The complete appraisal procedure can provide you with a good idea of the company’s strengths and limitations. If you want to discover how much your company is worth, you should seek the advice of a professional. A business valuation will assist you in determining the value of your company, assets, incurred income, and other factors. Our highly trained valuation team at Eqvista can assist you in determining the value of your company. To learn more about our valuation services, please contact us.

Interested in issuing & managing shares?

If you want to start issuing and managing shares, Try out our Eqvista App, it is free and all online!