Can the whole company value be greater than the sum of its parts? The answer is potentially yes in the context of a valuation of a minority interest for estate purposes. A minority interest in a company often lacks control of the company. The IRS requires a fair market value standard for valuations of interests that are being valued for estate purposes. Under a fair market value standard, a minority interest often has less value than its proportionate share of the business if the holder of the minority interest is not able to exercise the same influence as the control owner.
For example, the minority interest holder might not be able to compel a distribution, make financial decisions for the company or decide when it is time to sell the business. Therefore, an investment in a minority interest is reduced by a lack-of-control discount under a fair market value standard because an investor would not pay the same amount for a controlling interest as a noncontrolling interest that lacks decision-making ability. Additionally, minority interests are generally considered to be less marketable than a controlling interest, which means that a discount for lack of marketability might be appropriate as well.
Owners of a company can gift minority interests as part of an estate planning process. Let’s use an example of a company worth $1 million in total, owned by a father with three sons. If the father wanted to give 2% of his company to each son, the gifts would be valued at less than the proportionate share of $20,000, due to the fact that a 2% interest would not have control of the business and thus would be less valuable than an interest that had control. Discounts for lack of control and lack of marketability would be determined for the 2% ownership interests based on various company-specific factors.
The valuation analyst must review any shareholder/operating agreements to determine the amount of control of the interest, any restrictions on transferring the interest, if a redemption policy exists and the policy for distributions. In addition, the financial performance of the company, the nature and outlook of the company, the historical level of distributions, the quality of the management team, the expected holding period of the interest and any other factors that might affect marketability are analyzed to determine the level of discounts that are applicable to the ownership interest.
In this example, assuming a 10% lack-of-control discount and a 25% lack-of-marketability discount for illustration purposes, the value of a 2% minority interest would be $13,500. The father’s 94% interest in the company would be worth $940,000. Adding together that value with the value of three separate 2% interests ($940,000 + $13,500 + $13,500 + $13,500 = $980,500), results in a value which is less than the total company value of $1,000,000, on a controlling, marketable basis. Thus, in this instance, the whole company value is greater than the sum of its parts when valuing minority interests.
The IRS is known to challenge the amount of these discounts if the discounts applied to the minority interest are not properly supported. Schneider Downs has significant experience in preparing valuations of minority interests and supporting these discounts.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.