What are valuation discounts and how do we categorise them?

In the recent decision of Mignone & Barton [2024] FedCFamC2F 344, the Court found that as Mr XX valued the business at $437,000, the value of the Wife’s 50 per cent share was $218,500.

This simplistic view is all too common, where lawyers, accountants and even business valuers ignore discounts that can apply to when a company is not wholly owned.

Two discounts regularly applied in the valuation of a private company are:

• Discount for lack of control
• Discount for lack of marketability

Discount for lack of control (DLOC)

A discount for lack of control can apply when the ability of a shareholder to influence management and/or control of the company is encumbered having regard to the corporate documentation. 

For example, a company’s constitution and/or shareholder’s agreement may prevent a shareholder holding a certain level of shares the ability to influence the operations of the company including the appointment of Directors, the payment of dividends, the sale of assets or winding up of the company.  

Other common considerations under can include:

• the proceedings of Directors meetings
• the ability of a Party to approve and/or block special resolutions
• the ability of a Party to control the capital structure of the Company including issuing new shares or classes of shares, repurchasing outstanding shares or registering the company for an IPO
• the ability of a Party to decide on remuneration levels for employees, directors & officers
• the ability of a Party to enter contractual relationships with customers and/or suppliers
• the ability of a Party to conduct acquisitions/divest of businesses, divisions, assets
• the ability of a Party to decide on capital expenditure programs
• the ability of a Party to select the company’s strategy (including restructuring)
• the ability of a Party to veto or block any of the above actions

In relation to discount for lack of control of minority interests (shareholdings of 50 per cent or less), general control premium studies can provide supporting evidence as to the appropriate size of the discount.

However, the size of the discount will also depend on the interest of the stakeholder and the interest of the other shareholders, particularly where there is one shareholder that exerts significant control over the company. 

Discount for lack of marketability (DLOM)

A discount for lack of marketability is distinctly different in that the shareholder may be able to sell their shareholding however, there may be a limited number of potential buyers. A discount such as this is to recognise the impediments associated for a willing seller who may not be able to easily convert their minority shareholding into cash. 

Common considerations can include:

• the relative size of the parcel to other shareholders 
• transfer restrictions set out in corporate documentation (in particular pre-emptive and tag along/drag along rights)
• the dividend history of the company
• the underlying assets of the company
• the voting rights (or restrictions) associated with the shares held by the shareholder

In a public company context, thinly traded listed shares are an example where a discount for lack of marketability may be applied. This occurs when a shareholder holds a significant number of shares in a listed entity, but due to the lack of trading volume it may take the shareholder a considerable length of time to sell the parcel of shares, or where placing the entire holding onto the market is likely to see a reduction in the value of the listed shares.

There may be times where one, both or neither of DLOC / DLOM are appropriate when valuing an interest in a company and you should always seek expert advice when it comes to these issues in any litigation scenario. 

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