Valuing a minority interest in a private company

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Published: 16 Mar 2021


What is a minority interest?

By definition, a minority shareholding is one that is no more than 49% (ignoring fractions of a shareholding).

Trading shares on the stock exchange is equivalent to valuing each shareholding as a minority interest, unless an offer is made in the form of a takeover. Either way the shares are priced at market value through the exchange procedures.

How valuable is a minority interest?

For a private company, the sale of a minority interest may have its value adversely affected by the articles of association (the company “rule book”) restricting its marketability by the directors’ right of refusal to register a share transfer. This restriction is in place to keep the shares “within the family” or to avoid the founding shareholders losing control of the company.

In such instances, the value of a minority interest may be discounted to reflect a lower value than its proportionate share of the company. This can be avoided by the articles of association, or an overriding shareholders’ agreement, stating that all shares are valued on a pro rata basis to the value of the whole company.

What influence does a minority interest shareholder have?

In addition, case law supports a pro rata basis of valuation where the shareholders start and continue a company either as working or “sleeping” members. This is known as a “Quasi-partnership”, that is a partnership in all but name.

However, it is said that “beauty is in the eye of the beholder”. So even though a minority interest can be of little influence on the management of the company, its acquisition by an existing member can alter the scales of power within the company, if it makes the buyer a majority shareholder as a result. In this instance, market forces would encourage the buyer not to insist on too much of a discount on the minority interest.

Finally, since a minority shareholder is not able to decide on directors’ remuneration, or influence the management of the company and the amount of dividends payable, the valuation of the shareholding may be limited to its dividend yield. In other words, the only income a minority shareholder is entitled to is its share of dividends. Therefore, the valuation is limited to a multiple of the dividend, known as the dividend yield. The dividend yield for a public company is usually between 2% and 5%. Because of less resources and the greater risks involved for a private company, the dividend yield is usually between
10% and 30%.

When valuing share interests or transactions for taxation purposes, tax law only considers the shares under consideration as bought and sold between a “willing buyer” and a “willing seller”. It does not consider the resultant effect on existing shareholders. As a result, there is a discount on a sliding scale made by HMRC to the valuation to recognise the influence that a particular shareholding being sold or transferred may have.

If you have a minority interest in a company or have shareholders with a minority interest within your business and have concerns or questions in relation to valuing minority interests, please give David Cane a call on 07749 080 806 or email David at [email protected]