The Value of Control

Control Premiums, Minority Interest Discounts, and the Fair Market Value Standard

Kevin Kreitzman contributed to the first edition of BRG Review.

Control premiums applied in non-negotiated transactions of private securities represent the value that can be extracted from minority interests by controlling shareholders. The common practice of using observed acquisition premiums to justify excessive control premiums (or minority interest discounts) is misguided and not supported by the empirical evidence. This practice causes significant damage to the welfare of the general public and the millions of employees who rely on the integrity of these valuations. Small control premiums do persist despite laws to protect minority shareholders, even though such premiums should be eliminated if directors comply with their fiduciary responsibilities.

The value of control, as reflected in control premiums or minority interest discounts that are applied in business valuations, is an important matter since the integrity of business valuations is a requirement for the fairness of non-negotiated transactions of private securities, enforcement of the tax codes, and the viability of retirement plans for millions of employees. The common practice of using acquisition premium studies to justify control premiums of 25 to 40 percent or more is not supportable and causes significant damage to those relying on the integrity of these valuations as well as to the welfare of the general public. The term “control premium” is commonly used to refer to two distinct and unrelated measures: (1) the difference between the value of a controlling interest and a minority interest (sometimes also called a minority interest discount) and (2) an acquisition premium paid in a change of control transaction that is unrelated to the relative value of controlling and minority shares.1 Although acquisition premiums are not found in situations that require valuations to be performed according to the fair market value standard, they are often incorrectly added to interests in privately held firms that hold a majority of voting shares.2 Under the fair market value standard, premiums for control (or minority interest discounts) are based on an estimate of the amount of value that will be diverted to the controlling shareholders at the expense of the minority shareholders. The application of a control premium or a minority interest discount thus is an estimate of the amount of value that is expected to be appropriated from the minority shareholder by the controlling agent.