What are Valuation Premiums and Discounts?
IFRS 13 requires an entity to select inputs in a fair value measurement that are consistent with the characteristics of the asset or
liability that market participants would take account of.
Premiums and discounts are usually added to accommodate the effects of other factors related to the ownership interest of the business. Where a quoted price in an active market exists for the asset or liability, then that price is used without adjustment. Most
often, however, no such price exists and the fair value measurement should then incorporate premiums or discounts if market
participants would take them into account in a transaction for the asset or liability.
An example of how a control premium be applied can be seen when measuring the fair value of a controlling interest, or a discount for lack of marketability when comparing the shares of a private company to those of a comparable publicly listed company. A controlling interest is worth more than a minority interest on a per-share basis, since the former allows direct influence over major decisions that would affect the business direction.
- Control Premium
A controlling interest usually refers to having ‘more than 50% of the voting power’ in a business and hence it is more valuable than a non-controlling interest.
Premiums for such controlling interests can be from 30% to 50% of the base value.
- Strategic Acquisition Premium
This is used when a mergers and acquisition transaction helps to realize a strategic perspective, such as complementing an existing product line, broadening the market geographically, ensuring a source of supply or eliminating a key competitor for a particular buyer.
- Minority Interest Discount
This is also called ‘a discount for the lack of control’ and it serves a rationale opposite to that of the control premium. Hence a minority interest is typically less worthy.
- Lack of Marketability Discount
Ownership interests in private businesses would usually consider discounts for their lack of marketability.
Publicly traded equity shares are high in liquidity so they can be readily converted into cash near to prevailing prices.
As investors value liquidity, the lack of ability to sell the shares on a short notice at a market price will be considered a negative factor.
Restricted stock of public businesses which cannot be publicly traded would also use discounts for their lack of marketability, which can go from 20% to 70%.
- Lack of Control Discount
A Discount for Lack of Control is a fixed amount or percentage deducted from the selling price of a block of shares. The amount is deducted from the share value because that block of shares lacks some or all powers of control in the firm.
For example, a company in Singapore has two shareholders owning 70% and 30% each. If the total equity value of the company’s share is $ 1 million, then 30% would be $300,000. But a prospective buyer acquiring the smaller share of 30% reasonably would not agree to pay that much for the minority share since it does not have the power of control like that of the 70% shareholder.
The effect of the factors can also be applied prior to the result, such as adjusting the estimation of future income or cash flows when analysing the base value. It can also be applied during the calculations but usually after obtaining the base value of a business valuation, the valuation expert would consider the appropriate factors to identify the discounts and premiums for proper adjustments.
Needless to say, the application of premiums and discounts in the case of transactions (sale of shares as example) can result in a significant portion of the transaction price. Sometimes the shareholder’s agreement would include contractual provisions that determine the valuation process.
Speak with us a for a free consultation on how these valuations premiums and discounts apply to your case.
