Minority Shareholder Valuation

When a shareholder owns less than 50% of a company’s shares, the person is identified as a minority shareholder. Suppose a minority shareholder wants to sell the shares but is unsure about their value; here is where minority shareholder valuation comes in.

Minority shareholder valuation evaluates the value of minority shareholders’ stakes in a company. For example, if you possess 30% of a company’s total shares, you normally have limited voting rights. Valuing your shares will help you make decisions like selling or purchasing further shares regarding the business position and shares’ worth.

Also, another reason why it is important to conduct business valuations for minority shareholders is that if you know the firm is rapidly growing, but your share value does not match that growth, you should conduct a fair valuation to determine the value of your share in the company.

Minority shareholder valuation

A shareholder’s minority position in a company does not give them actual control over the company – So, how do we value minority interests in business? When valuing these shares, it is important to give them a discount.

The discount accounts for the following factors:

• These shareholders have little say over the company’s decisions, including dividends and voting rights.
• Share transfers are limited or, in some cases, restricted.
• There may be no market for these shares.

Who are minority shareholders?

As we know, a minority shareholder holds less than half of the company’s shares. Unlike the majority shareholders, who own more than 50% of the company’s shares, minority owners have restricted rights.

A minority shareholder can have some power, but they do not have complete control as majority shareholders do. Their rights are limited to:

• Election of company’s directors
• Participating in company’s meetings
• Receive dividends
• To inspect company records to the shareholder’s interest

It is important to note that the directors and the majority shareholders should act in the best interest of the company and its minority shareholders.

The rights and interests of the minority shareholders are crucial for maintaining a healthy business environment and preventing the exploitation of the majority shareholders. They can also file a petition on grounds of mistreatment or mismanagement.

Case study for Minority shareholders

John, a minority shareholder in BrightTech Inc., owns 10,000 shares (1% of the company). John believes his shares are worth more than the majority shareholders offer to buy him out for. To resolve the dispute, both parties agree to an independent valuation:

• Total Shares Outstanding -1,000,000 shares
• Minority Shareholder Ownership – 10,000 shares
• Annual Revenue – $5,000,000
• Net Income – $500,000

Valuation Steps

• Determine the Total Company Value (Enterprise Value):
  Using the Price-to-Earnings (P/E) ratio:
  Total Company Value = Net Income × P/E Ratio = $500,000×10 = $5,000,000
• Calculate the Per Share Value:
  Per Share Value = $5,000,000 / 1,000,000 shares = $5 per share
• Determine the Value of the Minority Shareholder’s Stake:
  Minority Shareholder Value = 10,000 shares × $5 per share = $50,000
• Apply Minority Discount (20%):
  Discounted Minority Shareholder Value = $50,000 × 0.80 = $40,000
• Apply Marketability Discount (15%):
  Marketability Discounted Value = $40,000 × 0.85 = $34,000

The independent valuation concludes that John’s shares are worth $34,000, providing a fair basis for the buyout offer and reducing disputes. Both parties use the credible valuation as a foundation for smoother discussions and resolutions. The detailed valuation supports the fairness of the buyout offer, aiding potential court settlements, and reassuring John, increasing the likelihood of accepting the buyout without litigation, thus saving time and costs.

Factors Influencing Minority Shareholder Valuation

Several things go into conducting the minority shareholder valuation. Let’s find out what they are:

Company Financial Performance and Growth Prospects

The value of the minority shareholder is affected by how well the business does and how much room it has to grow. Strong financial success, which includes:

• Revenue growth
• Profitability and
• Generate cash flow

Minority shares may also be worth more if the company expands into new markets, develops new products, and forms partnerships.

Market Conditions and Industry Trends

How much minority owners are worth could change if the market trends vary. When the market is unpredictable and prices vary frequently, investors expect a higher risk of retaining their shares. Also, External markets such as:

• Overall economic health
• Market instability and
• Industry-specific changes

All of these factors can influence minority shareholder valuation. For example, a succeeding business or a favorable trend might result in greater values, but recessions or unfavorable market conditions can cause share prices to fall.

Minority Shareholder Rights and Protections

The rights and protections of minority shareholders could make their part of the company more valuable. It includes the following things:

• Level of control – A minority stakeholder’s share value is affected by how much power they have. As an investor’s level of control decreases, the minority discount rate increases.
• Liquidity – Selling minority shares is more challenging and cannot be purchased as readily. People who own minority shares might have difficulty selling them so they might offer them at a low price.
• Size of ownership interest – smaller ownership stakes often have huge discount rates because they have limited capacity in business operations.

Besides these, the rights of minority shareholders to view and inspect the company’s records, vote, and get dividends can all affect the minority shareholder valuation.

Legal and Regulatory Environment

The laws and rules that the company has to follow may affect how much a minority interest is worth. Minority shares may lose value if the business has to deal with many legal disputes and changes in the law.

On the other hand, a stable and helpful legal system makes investors believe the legal system leads to higher valuations.

Key Considerations in Minority Shareholder Valuation

If you want to figure out how much your minority shares are worth, you should consider the following points.

Selection of Appropriate Valuation Methodology

Select a valuation approach appropriate for the company’s needs and minority shareholder stake. Common valuation methods include:

• Discounted Cash Flow Method (DCF)
• Capitalization of Future Maintainable Dividends (CFMD)
• Capitalization of Future Maintainable Earnings (CFME)
• Adjusted Book Value (ABV)

Consider the company’s growth potential and financial performance when deciding on a valuation technique.

Weighting Factors and Adjustments in Valuation Models

After selecting a valuation method, the next step is to modify the valuation models to reflect the minority interest’s lack of control and marketability. Apply the appropriate discounts for lack of control (DLOC) and lack of marketability (DLOM) to compensate for minority shareholders’ reduced decision-making power and sale of shares.

Consider other factors, such as voting rights and possible restrictions on share transfers.

Use of Professional Valuation Experts and Advisors

Help from specialists and advisors who have performed minority shareholder valuations and used relevant methodology and standards. Also, be sure that their valuation method is impartial.

Seeking expert advice can also help in difficult valuation issues and conflicts.

Negotiation Strategies and Tactics for Minority Shareholders

Understand the minority shareholder’s rights and protections under relevant laws, regulations, and shareholder agreements. Prepare thoroughly by doing a valuation analysis to know the strengths and limitations of your position within the company.

Consider alternative dispute resolution methods like mediation or arbitration to resolve valuation issues. Consider minority shareholder protection or exit strategies, such as:

• Tag-Along – allows minority shareholders to sell at the same price and terms as majority shareholders.
• Drag-Along – In this case, the majority shareholder coerces the minority interests into selling their shares with them.

How do we value minority interest in business?

Valuers use several methods to determine a minority’s shares in a business. Some of the common approaches include:

• Discounted Cash Flow Method (DCF)
• Capitalization of Future Maintainable Dividends (CFMD)
• Capitalization of Future Maintainable Earnings (CFME)
• Adjusted Book Value (ABV)

Minority Shareholder Valuation approaches

Let’s understand the concept of all the valuation types mentioned above.

• Discounted Cash Flow Method (DCF) – The DCF method assesses an investment’s value by considering future cash flows. It helps determine the value of those future cash flows based on discount rates. DCF answers, “How much is the investment worth today, given its expected future returns?” When valuing a minority interest in the company, the Discounted Cash Flow (DCF) method uses the net cash flow of dividends paid to the investor.
• Capitalization of Future Maintainable Dividends (CFMD) – For minority shareholders who have shares in private companies that pay dividends, CFMD can be important. This method calculates the future dividend value to show the net present value of the future income a minority shareholder will receive. The income is a return on their investment. Using this method can be helpful when the minority shareholder’s rights are limited in company decisions and they cannot get their share of the company by selling it.
• Capitalization of Future Maintainable Earnings (CFME) – CFME is the most widely acknowledged strategy, which involves capitalizing future maintainable earnings at a sufficient rate or multiple. This method replaces the Discounted Cash Flow (DCF) method and needs consideration of various aspects, including: Valuers forecast future earnings by looking at past performance and what they expect in the future.Choosing the appropriate capitalization rate will show the company’s risks in growth and the overall financial condition.
• Adjusted Book Value (ABV) – When a business isn’t trading or its net running assets are higher than its enterprise value, the adjusted book value method is often the best way to determine its worth. Investors find this out by considering how much money they think the business will make. They do this using methods such as capitalizing future maintainable earnings. Companies change the book value of their assets and debts to better reflect what they are worth on the market.

Need Help in Business Valuation?

The minority shareholder valuation is very important for determining the company’s worth. It is important to consider the ownership structure, rights, and risks of having minority shares in a company when determining the value.

Eqvista offers specialized services and products to help you carefully review and handle business situations. Eqvista is easy to use and has knowledge of share management; it’s easy to find out how much minority shares are worth, make accurate reports, and make smart financial choices. Are you looking for an exact value for your business? Please get in touch with us right away!