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Val Discounts |
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Valuation Discounts
What & When To Discount
Lack Of Marketability
Thin Management, Key Man
Control Premium
What & When To Discount
It's possible to apply certain discounts when valuing closely held companies. The most common reasons to discount are for lack of liquidity or marketability and lack of control. Any discount will eventually be judged and accepted or rejected by the IRS, so valuators must back up their discount recommendations carefully, with studies and past court cases, if possible in the jurisdiction.
Lack Of Marketability
Closely held companies usually don't have a recognized market for their stock, and the stock isn't readily transferable. For these reasons, a lack of marketability discount is typically applied to the stock's value.
Stock is often discounted between 20% and 40% for lack of marketability. One method the valuator might use to find the right discount would be to compare the stock to stock classified as "restricted," either in the same or a comparable company. Restricted stock has marketability problems that have been specifically addressed by the IRS.
Factors to be considered when dealing with lack of marketability include:
 | How much the business is in; |
| Does the seller need money from selling to live; |
| The period of time it would likely take to sell the stock; |
| The company's policies on paying dividends and redeeming shares;
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| How solid the company's capitalization is, i.e., its debt vs.
equity. |
| Brokering and legal costs required to sell the company. |
Thin Management, Key Man
A key individual may be so essential to a closely held company that his or her death or departure would cause serious financial harm. This might justify a "key man" stock valuation discount or an upward adjustment in the valuation discount rate to compensate for the risk associated with the company's dependence on a "key man." The valuator must quantify the effect of a key person's absence on the company's future earnings. The price of any agreements not to compete might be used to determine this.
Control Premium
When a valuation is performed using data and input based on minority interest sales data in the subject company or a comparable company, a premium is applied if an owner has more than a 50% equity interest. The premium reflects the fact that such an acquirer will have greater control over the company than a minority shareholder.
For instance, a person with a controlling interest can put management in place, determine company policy, decide to acquire or liquidate company assets, and declare and pay dividends. |
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