Factors affecting adjustments in valuation
The value of an ownership interest in a business enterprise may be subject to the adjustment of a valuation premium or discount for the following issues,
- Ownership control
This rationale for the adjustment is explained as follows.
The value of a fractional interest investment in a business enterprise is not necessarily equal to a pro rata percentage of the overall value of the entire enterprise. A fractional interest in a business enterprise that has little or no voice in company affairs, by definition, suffers from a lack of ownership control. Such a fractional ownership interest is sometimes referred to as a “minority interest.” Unless there is a statutory, contractual, or other reason that prevents it, the value of a minority interest in a business enterprise is usually less than the pro rata percentage of the overall value of that business enterprise.
The factors affecting the discount for lack of control (DLOC) basically evolves from the fact that Non-Control owners cannot control.
- Resource allocation
- Appointment of management and advisors
- Management compensation and perquisites
- Acquisitions and divestitures
- Distribution policy
- Asset acquisition and divestiture
- Registration of the Corporation or Partnership’s securities for
- public offerings
- Prevention of any of these actions
The concept of investment marketability relates to the liquidity of an investment—that is, how quickly and certainly the investment can be converted into cash at the owner’s discretion. Investors value liquidity. Rational investors will pay a price premium for liquidity. Conversely, rational investors will demand a price discount for lack of liquidity.
The reasons for the discount for lack of marketability (DLOM) are as follows.
- Illiquidity or limited liquidity
- Restrictions on transfer
- Untimely or incomplete information
Some minority ownership interests are subject to non-systematic risk-related valuation discounts, such as.
- Key person dependence,
- Key customer dependence,
- Key product dependence,
- Obsolescence of technology or facilities, and
- Built-in capital gains.