Premiums and Discounts in Valuation

Control premiums, minority discounts and illiquidity adjustments
A company's value depends not only on intrinsic value, but also on the nature of ownership—controlling vs minority stake, liquidity. Premiums and discounts adjust value for a specific ownership context.

Levels of value

Control, marketable: 100% ownership of a public company. Highest value—full control plus liquidity.
Minority, marketable: small stake in a public company. Trading price reflects this. No control, but liquid.
Control, non-marketable: 100% ownership of a private company. Has control, but can't easily sell.
Minority, non-marketable: small stake in a private company. No control, no liquidity. Lowest relative value.

Control premium
Control premium: excess value for a controlling stake over a minority stake. The buyer pays more for control.

Sources of control value: ability to determine strategy, management, capital allocation; synergies with buyer's business; access to 100% of cash flows (vs pro-rata dividends).

Measuring premium: in M&A, compare the offer price to the pre-announcement trading price. The difference equals the premium paid.

Typical range: 20-40% in most M&A deals. Varies by deal rationale, competition among buyers, and the target's bargaining power.

Minority discount
The flip side of the control premium. Minority stake is worth less due to lack of control.

Minority discount = $1 - \left(\frac{1}{1 + \text{Control Premium}}\right)$.
If control premium is 30%, minority discount = $1 - \left(\frac{1}{1.30}\right) = 23%$.

Application: valuing a minority stake from a control-level value.
Control value $100M$, 30% premium → minority value ≈ $77M$.

Lack of Marketability Discount (DLOM)
Illiquidity discount: shares of a private company lack a ready market. Can't sell easily at fair price.

Sources: transaction costs are high, no price discovery, lengthy sale process, buyer search costs.

Evidence: restricted stock studies (discount for restricted vs unrestricted shares), pre-IPO studies (discount from IPO price).

Range: 15-35% typical. Higher for smaller companies, longer expected holding periods, less stable businesses.

Calculating DLOM

Restricted stock studies: compare the price of restricted (can't trade) vs registered shares. The difference is the marketability discount.
Pre-IPO studies: compare private transaction prices to subsequent IPO price. Private trades at a discount.
Put option models: treat illiquidity as the cost of a protective put (right to sell at fair value). Option cost estimates the discount.

Key person discount
If company value depends heavily on one individual (founder, key executive), risk exists if the person leaves or becomes incapacitated.

Discount reflects: probability of departure/incapacity, impact on business, ability to replace.

Range: 10-25% in extreme cases. Less if succession plan or team depth exists.

Blockage discount
For very large blocks of stock, selling at once would depress price. Discount for market impact of selling.

Relevant: for holders of > 10-20% of float. Normal trading can't absorb block without price impact.

Estimate: based on historical price impact studies, block trade discounts observed.

Applying premiums/discounts
Sequence matters: typically apply minority discount first (if starting from control value), then DLOM.

Minority + DLOM:
$\text{Minority Value} = \text{Control Value} \times (1 - \text{Minority Discount}) \times (1 - \text{DLOM})$

Example: Control value $10M$, 25% minority discount, 20% DLOM.
Minority, non-marketable value $= $10M \times 0.75 \times 0.80 = $6M$.

M&A synergies
Synergies: additional value created by combining two companies.

Cost synergies (eliminate duplicates)
Revenue synergies (cross-selling)

Standalone value: target's value assuming no acquisition. DCF of target's standalone projections.

Combined value: target's value in combined entity, including synergies.
$\text{Combined Value} = \text{Standalone} + \text{Synergies}$

Synergy split: negotiation determines how synergies are shared between buyer and seller. Premium reflects seller's share of synergies.

Valuation in M&A context
Minimum price: standalone value plus premium seller requires. Seller won't accept less.

Maximum price: standalone value plus synergies. Buyer shouldn't pay more (all synergies to seller).

Deal price: somewhere between. Split reflects bargaining power, competition, negotiation.

Practical considerations
Context matters: the same company has different values depending on ownership characteristics. Specify what you're valuing.

Document basis: clearly state if valuation is control/minority, marketable/non-marketable.

Adjustments depend on starting point.

Avoid double-counting: if using public company comps (minority, marketable), don't apply minority discount again. Comps already reflect minority level.

Support discounts: premiums/discounts often challenged (tax, litigation). Provide empirical support for rates used.