Value Blog

Within the valuation community the trend has been to refer to “minority” interests as non-controlling interests.  The issue is really whether an owner has control, not how much of a company he owns.  In determining whether an interest is in fact a controlling or non-controlling interest I consider both the rights granted by agreement and by law, as well as what goes on in the business.

Some of the benefits of having control include:

• The ability to elect directors and appoint management
• Determine management compensation and benefits
• Set policy and change the course of business
• Acquire or liquidate assets
• Make acquisitions of other companies
• Liquidate, dissolve, sell out or recapitalize the company
• Sell or acquire treasury shares
• Register the company’s stock for public offering
• Declare and pay dividends or make distributions to owners
• Change the articles of incorporation or bylaws

While some owners feel that control over dividends or distributions is one of the most important aspects of control,  it is not the only aspect which can impact ownership.

In evaluating whether an interest is controlling or non-controlling, I consider how much not having these benefits impact a non-controlling interest.  A few examples may illustrate when a non-controlling interest could be impacted:

• A partnership receives an above market offer for a piece of real estate it owns.  The partner who wants to sell owns 51%.  However, the partnership agreements provides that in order to sell the assets, at least 75% of the ownership must agree to the sale.  The other partners owning 49% refuses to sell.  The opportunity may be lost because the 51% partner does not have control.
• A 10% shareholder works for a company.  He has been paid a salary in the past.  However, his position and salary are eliminated by the management of the company.  He remains a shareholder, but does not have the control necessary to reinstate his position or pay himself a salary.
• An S Corporation, which passes through its income to its shareholders, had profits, but management refuses to disburse money for the owners to pay taxes.  The shareholders agreement says that management at its sole discretion will determine annual distributions.  A non-controlling shareholder cannot force a distribution.

These situations represent real life scenarios where controlling shareholders have been at a financial disadvantage as a result of their lack of control.  In some cases, owners who have more than 50% of the equity may still not have control.  In others, shareholder agreements can give owners with less than 50% ownership control over a company in the form of being appointed as management, the right to hold seat(s) on the board or by virtue of by other shareholders not having voting rights.

In general, non-controlling interests are worth less than controlling interests.  Depending upon the standard of value and purposes of the valuation, a discount for lack of control may apply.

©2010 Florida Business Valuation Group

After speaking to Marty Fishman, a business broker with Transworld Business Brokers, about what buyers are looking for he had the following insights: “Most buyers approach the purchase with a certain level of skepticism. Buyers want solid facts and believable information that a business opportunity is a solid investment. They want information: financial documents, business operation and facility information. Some of this information will be provided prior to an offer and some of it once there has been an executed purchase agreement with contingencies such as the complete and satisfactory review of property, books and records.”

This is in line with the things that I evaluate as a business appraiser that support the value of a business.  Those businesses with good records and documentation of business operations are worth more than businesses that are lacking.  I will go a step further to say, businesses with limited records are significantly less marketable than businesses with good records.

Since buyers approach businesses with skepticism, consistent records are also important.  As a consultant, I advise clients to rely upon tax returns that have been filed with the IRS under penalty of perjury, over hand written documents that track sales.  In cases where cash sales were not reported on a business’s income tax return (or sales tax returns), there may be inadequate documentation of the amount of unreported cash, leaving the buyer with the difficult decision of accepting the seller’s representations on faith.  I advise clients to consider that if a seller was less than truthful in reporting income to the IRS or other taxing authority, how does one know he or she will be truthful in the amount of unreported cash to the buyer.

Mr. Fishman pointed out “The selling and buying of a business is a very complex process. It involves many aspects that most successful business people are not exposed to in day-to-day operation of a company. Both parties should rely on experts trained in the sale of businesses.”

It is important to keep in mind that when you are buying or selling a business, the price is often based on a number of factors, and the buyer and seller may value the business differently.

©2010 Florida Business Valuation Group