How Does Control Affect Stock Value?
By Robert B. Morrison, ASA BV/IA
There is significant value in the ability to control ordinary and critical business decisions of a business enterprise. Those in control can, as an example, choose to use corporate revenues to pay discretionary expenses such as club dues and compensation to family members. Control owners may also choose to pay themselves rent or salary that does not reflect market rates. Finally, control owners may choose to use company capital to acquire non-operating assets such as vacation homes or aircraft. In these situations, non-controlling owners have no power or authority to stop the controlling owner(s) from using corporate funds and capital for activities that do not create shareholder value, a fact that negatively impacts the value of the shares held by non-controlling owners.
There is also significant value in the ability to convert stock holdings to cash when desired. There typically is no ready-market for shares in privately-held companies. Because of this, the holder of such stock bears tremendous risk in the volatility of the value of that stock between the point in time they decide to sell and the point in time the sale may be completed. Again, there may be significant impact on the value of the shares from this lack of marketability and illiquidity.
How much is this combined impact on value? It depends…it depends on the extent to which the controlling owner(s) has control and to which the non-controlling owner(s) lacks control, the expected volatility of the stock’s underlying value, and the length of time to a liquidity event.
Levels of Value
There are four basic levels of value when considering interests in business entities:
- 100 percent control: The holder of 100 percent of the outstanding equity of a business may do what they want with the assets and cash flows of the business (subject to loan covenants and statutes). They have complete control over all business and strategic decisions. They can provide liquidity by selling assets, borrowing funds, or selling equity in the company. In valuing a 100 percent controlling interest the valuation analyst may consider an asset or stock transaction as the 100 percent controlling owner can chose to do either.
- Less than 100 percent control: Owners of interests of between 50 percent and 100 percent of the equity interests have varying degrees of control over the assets, cash flows, and decision-making of business enterprises, depending on the terms of the governing ownership agreement (i.e., stockholder, partnership, or operating,) and on local statutes. The ownership agreement may require a super-majority or even unanimous vote for certain actions. The ownership agreement may grant all major decisions to a single or limited number of individuals regardless of their ownership interest (e.g., general partner of a limited partnership; manager of a limited liability company). In the absence of an ownership agreement, statutes may impact how this issue is addressed. In any event, when valuing such an interest, the valuation analyst must remember that they are valuing a security, not the assets of the company, introducing the concepts of illiquidity and lack of marketability in addition to possible lack of control.
- Non-controlling, marketable (also known as non-controlling, as if freely traded): As the name suggests, the holder of a non-controlling, marketable interest lacks the prerogatives of control enjoyed by the holder of the controlling interest(s) in the company. However, the interest is marketable in that there is an efficient, ready market through which the interest may be sold with minimal cost or impact on the value of the interest. Another issue to be addressed by the valuation analyst is whether the interest, while marketable, is also liquid. There are many publicly-traded stocks that are marketable (registered and quoted, for example, on NASDAQ) but, due to the nature of the company, its stock, and the size of the interest, are illiquid.
- Non-controlling, non-marketable, illiquid: This level is most synonymous with a small, “minority” interest in a privately-held company. The size of the interest is so small that it not only lacks control, but is also lacks any influence with the controlling owner(s). It is non-marketable because there is no market or quotation platform through which the interest may be marketed. It is illiquid because there is no demand for the interest and there is no liquidity event on the horizon.
Lack of control and illiquidity of stock may materially affect value. Before attempting to estimate the magnitude of that impact, a complete understanding of the rights that inure to the subject stock and the avenues available to liquidate the stock is necessary. American Business Appraisers’ members have the training and expertise to assist with this analysis.
Robert B. (“Bob”) Morrison, ASA BV/IA is the Managing Partner of Morrison Valuation & Forensic Services, LLC in Orlando. Bob is the elected International President of the American Society of Appraisers (ASA). Bob holds the Accredited Senior Appraiser certification and the Intangible Asset specialty designation conferred by the American Society of Appraisers.