Business Valuations Blog

The Basics of Valuation Discounts

We, as consumers, love discounts. There are few things more satisfying for a savvy shopper than finding a deal on an item that he or she has been longing for. When it comes to valuing a business, some believe that “discount” is a dirty word and that it implies that the seller is not receiving fair market value for his ownership interest and that the buyer is getting a deal. This is not the case, however, as valuation discounts merely adjust the value of an ownership interest indicated by certain valuation methods for specific characteristics that need to be addressed before arriving at fair market value. 

 

The most common discounts seen in valuation reports are for lack of control and lack of marketability. 

 

Lack of Control Discounts

 

Lack of control discounts are appropriate for ownership interests in which the owner cannot unilaterally direct the company’s operation. A lack of control discount is applied because a non-controlling owner cannot appoint management, set levels of management compensation, declare dividends or distributions, compel a liquidation of his or her ownership interest, set company policies, or purchase or sell assets, just to name a few things. These factors make a non-controlling interest less valuable than a controlling interest.

 

Marketability Discounts

 

Marketability discounts are also often appropriate in the valuation of privately-held businesses.  There are certain marketability differences between an interest in a privately-held business and an interest in the stock of a publicly-traded company. An owner of publicly-traded securities can know at all times the market value of his or her holding based on the quoted price per share. He or she can sell that holding on virtually a moment’s notice and receive cash, net of brokerage fees, within several working days.

 

This is not the case with ownership interests in privately-held companies, however. Liquidating or selling a position in a privately-held company is a more costly, uncertain, and time-consuming process than selling the stock of a publicly-traded company. An investment in which the owner can achieve liquidity in a timely fashion is worth more than an investment in which the owner cannot liquidate the investment quickly. Therefore, an ownership interest in a privately-held company with the exact same characteristics as a publicly-traded company would sell at a discount compared to the publicly-traded company.

 

What Does It All Mean?

 

Valuation discounts are not a simple matter, but they are an essential part of determining the fair market value of ownership interests in privately-held companies. The subjectivity in determining valuation discounts is often a source of contention in valuations for divorce, shareholder disputes, and estate and gift tax filings. Therefore, it is essential that your business valuation analyst have a well-reasoned and thorough discount analysis in order to stand up to challenge or scrutiny. 

 

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Services at 440-449-6800 for more information.


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