When Ari Gold, a character from the HBO critically acclaimed series “Entourage”, was negotiating the purchase of the McQuewick Agency with Terrence McQuewick, Ari’s former boss and sworn enemy, Terrence was offering to sell the Agency to Ari without the consent of Terrence’s other partners. It was obvious that Terrence didn’t obtain his partners’ approval given their reaction once Ari took control of the Agency (they were less than pleased).
The story line in this episode isn’t far from reality, except when Ari goes through the McQuewick Agency with a paintball gun and shoots talent agents that he doesn’t want in “his” newly acquired company. Reality is expressed in the decision making actions of Terrence and Ari. They were the controlling owners who made the negotiation and got what they wanted. The other partners (some of whom were covered in paint) were not as fortunate. From a business valuation perspective, the point is that differences in ownership control make a significant difference in the value of an equity ownership interest in a company.
All else equal, control drives more value. Controlling owners are able to exercise their power over the matters of their companies, while their non-controlling counterparts are more often than not along for the ride and are subject to the controlling owners’ decisions, good or bad (think of Terrence’s partners).
Control is usually defined by ownership percentage, but it can also be measured based on voting rights, voting shares or managing-member authority to name a few. This critical difference comes into play in the context of a business valuation when a valuator is determining the lack of control (minority) discount to be applied to an ownership interest.
We already noted the benefits of having controlling authority of a company. These rights of control translate into higher equity values. Conversely, non-controlling owners have fewer beneficial rights, which translate into lack of control discounts that produce lower equity values.
As long as this is conceptually understood, measuring the difference in discounts is a matter of both art and science for the business valuator. The science is based on extracting empirical data from a variety of studies and databases, some of which focus on merger control premiums and closed-end funds. The art involves blending the results of these studies with specific facts and circumstances of the subject company to arrive at an appropriate lack of control discount for minority interests.
It is critical to understand that not all owners are created equal. Authority and control are desirable attributes that create meaningful differences in value. So, before you think about treating all owners as holding equal per unit equity values, think about the partners covered in paint after Ari purchased the controlling ownership of the McQuewick Agency. Those partners would say they got something…it just wasn’t valuable.
For more information on our Business Valuation & Litigation Advisory Services, contact Joe Yusz by leaving a message below or by calling 440-449-6800.