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An Overview of Valuation Discounts

December 17, 2015

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When determining the fair market value (“FMV”) of a business interest, valuators often consider if any valuation discounts exist and if they need to be applied to a value otherwise determined.

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For example, when a shareholder does not own 100% of a company a valuator will first determine the FMV of the company and then establish what the rateable value is for the shareholder’s interest. The rateable value represents a pro-rata portion of en bloc value. It is before consideration of any valuation discounts.

Next, the valuator considers valuation discounts that may be applicable to the engagement. In general, valuation discounts refer to a reduction from the rateable en bloc value of an ownership interest to recognize one or more of the following disadvantages:

  • Lack of control: The absence of voting control implies the inability to dictate matters such as the future direction of the corporation, the election of directors or dividend payments. When these investment limitations (i.e., lack of control) are present and are not specifically addressed in a shareholders’ agreement, a minority discount would typically be applied to the pro-rata value of a non-controlling interest.
  • Lack of marketability: An investment in a closely held corporation may be somewhat illiquid because a sale to a private purchaser would take time and involve costs. In some cases there may be restrictions placed on the transfer of shares that would increase the time, cost and risks of marketing the ownership interest. This inherent lack of liquidity (i.e., lack of marketability) may require a liquidity discount to be applied to the value of a non-controlling ownership interest.

After factoring in appropriate valuation discounts, the valuator will determine the FMV of the shareholder’s interest in the company. Although, it has been observed that valuation discounts may not always be applicable. Even when valuation discounts are applied, the discount applied to the rateable value varies amongst different companies whereby the discount applied is often case-specific, dependent on the varying factors involved in the valuation engagement.

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