What Does Minority Discount Mean?
A minority discount is the reduction applied to the valuation of a minority equity position in a company due to the absence of control. Minority shareholders usually have the inability to dictate the future strategic direction of the company, the election of directors, the nature, quantum and timing of their return on investment, or even the sale of their own shares. This absence of control reduces the value of the minority equity position against the total enterprise value of the company.
Let's take a company that has two shareholders owning 70% and 30% each. If the company's equity value is $10,000,000, an astute buyer looking to acquire the 30% position would not pay $3,000,000 because of the lack of control attached to this minority shareholding.
Divestopedia Explains Minority Discount
Most publicly traded shares held in stock portfolios represent a minority shareholding and are assumed to trade at a discount when compared to their pro-rated equity value for 100% of the company. This discount is evident in takeover bids when a buyer offers to pay a premium over the stock price in order to own a controlling interest in the equity of the company. For this reason, a proxy for a quantification of the minority discount is made by assessing the control premiums paid in the market place. Historical studies have shown that control premiums paid on the acquisition of public companies have typically ranged from 25-50%.
Minority shareholders in a business should clearly define in a unanimous shareholder agreement (USA) the valuation methodology, including the application of a minority discount on the buyout of their equity.