Minority interest states owning less than 50% of any company, which means an investor or the shareholder might not have control over any important decisions such as management, dividend policies or strategy. Valuation plays an important role in acquisitions, mergers, legal cases and financial reporting.
Know about minority interest
Minority interest is the share of the equity in any company that is owned by any shareholders not dominating or controlling the business. This primarily happens in case of joint ventures, family-owned businesses or the subsidiaries where a person preserves specific part of the company. The minority shareholder possess his share of gains and assets and do not have any control on decision making, thereby affecting the ownership value.
Factors affecting the value of minority interest
- Lack of control: A minority shareholder can never offer any kind of influence over major decisions, and therefore his stake is not as attractive as a controlling interest. There is a "discount for lack of control" (DLOC) in valuation because of the lack of control over the company.
- Lack of marketability: Minority interests, as a group, are relatively illiquid or otherwise cannot be readily sold and transferred. And that introduces a "discount for lack of marketability" (DLOM). Thus, that also reduces the value of minority interests.
- Company performance: The general financial situation as well as business performance to a huge extent define what the minority interests will be worth for. A profitable business in growth mode will command a far better valuation than over the minority shareholders.
- Industry and market conditions: Value for minority interest also rests quite largely on the extraneous conditions that include industry growth, economic conditions as well as competitions prevailing in the market.
- Industrial and market conditions: External factors such as industrial growth, economic conditions as well as market competitions also play a vital role in determination of minority stake value.
- Voting rights and restrictions: Some of the minority stakes might involve restricted voting rights on transfer of ownership that can further affect the process of valuation.
Methods for estimating minority Interest
Discounted cash flow method: It calculates the future cash flows an enterprise can generate and translates those cash flows into their present values. Discount appropriate DLOC and DLOM for the lack of control and marketability of minority interest.
Comparable company analysis: Valuation method uses an approach to calculate the value of the minority interest by matching with existing values of businesses available in the market.
Net asset value method: The method computes the total assets less liabilities and subsequently uses proportional ownership in the valuation of the minority stake.
Conclusion
Minority interest valuation is the process that entails thorough knowledge of both the internal and external factors influencing the business. It is a very complex procedure requiring the specific use of discounts to account for the lack of control and marketability in order to determine a reasonable value. Minority interest valuation is important for just and fair handling of transactions, reporting, and guarding the rights of minority shareholders. Strong methods of valuation like gift tax valuation ensure business transparency and the fairness of dealings in the minority stakes.