Valuation Discounts and Premiums

Public company valuations are based on liquid share exchange, while private company valuations adjust for control and limited share exchange. The highest value comes from a strategic buyer with synergy potential and a willingness to assume execution risk. Financial buyers may pay a premium for control but may lack synergy or expertise. Marketable non-controlling equity matches public market prices. Discounts for control and marketability are discussed further, with variations based on context, data comparability, shareholding size, legal factors, and more. Timing matters, as private companies eyeing IPOs or strategic sales have lower discounts, while those without dividends or liquidity prospects have higher ones. Control and/or marketability adjustments are often included in valuations of interests in private companies.

Discount For Lack of Control (DLOC)

The discount for lack of control is a reduction in a company’s share value as a result of a shareholder being unable to exercise his or her control over the company. This is necessary for valuing non-controlling equity interests in private companies if the value of total equity was developed on a controlling interest basis.

For a private company, the discount is higher when the company has not paid dividends and has no probability of going public. On the other hand, the discount is lower when a private company is seeking an IPO and when it is a strategic sale.

$$\text{DLOC}=1-\bigg[\frac{1}{1+\text{Control premium}}\bigg]$$

Example: DLOC

If the control premium is 15%, then:

$$\text{DLOC}=1-\bigg[\frac{1}{1.15}\bigg]=13\%$$

The application of DLOC varies:

• If the investor values the company from a non-controlling perspective, so the DLOC should be applied.
• If the investor values the company from a controlling perspective, then a DLOC should not be applied.

Lack of Marketability Discounts (DLOM)

A discount for lack of marketability is the percentage deducted from the value of an ownership interest to reflect the relative absence of a ready market for a company's shares compared with publicly traded companies. It is applied to the valuation of noncontrolling equity interests in private companies.

Factors that Increase DLOM

• Restriction on the sale of shares.
• Restrictions on transferability.
• Higher risk.
• Greater uncertainty of value.
• Concentration of ownership.

Factors that Decrease DLOM

• High prospects for liquidity.
• Payments of dividends.
• Large pool of potential buyers.
• Duration of asset.

The value of equity interest is then calculated as:

$$\begin{align*}\text{Estimated value of equity interest}&=\text{Pro rata value of equity interest}\\& \times(1-\text{Control discount})\\&\times(1-\text{Marketability discount})\end{align*}$$

Example: Calculating the Estimated Value of Equity Interest

Given a DLOC of 15% and DLOM of 11%:

$$\begin{align*}\text{Total discount}&=1-[(1-\text{DLOC})(1-\text{DLOM})]\\&=1-[(1-0.15)(1-0.11)] \\&= 0.243 \\&= 24.3\%\end{align*}$$

Question

For a company with a discount for lack control is 8% and a discount for lack of marketability of 9%, the total discount is closest to:

1. 16.28%.
2. 17%.
3. 17.14%

Solution

The correct answer is A.

$$\begin{align*}\text{Total discount}&=1-(1-0.08)(1-0.09)\\&=0.1628\\&=16.28\%\end{align*}$$

Reading 27: Private Company Valuation

LOS 27 (f) Explain and evaluate the effects on private company valuations of discounts and premiums based on control and marketability.