You cannot calculate partial interests in a given business with simple mathematics. This stands true for both fractional and minority ownership. To calculate the interest accurately, you need to consider a series of factors, including liquidity, marketability, and control, among others.

The section below talks about some such crucial influencing factors. These are factors that estate tax valuation service providers never ignore when calculating minority business ownership. The write-up also talks about common methods adopted by valuation professionals to calculate minority ownership interest.

Factors to Consider When Calculating Minority Ownership Interest

DLOC: The abbreviation DLOC stands for Discount for Lack of Control. When there’s zero control, the value of minority shares drops significantly. This happens due to the limited control owned by the minority shareholder. In DLOC, the term discount (represented by D) is used to reflect the limited capacity the minority shareholders have when it comes to influencing governance. They lack the power to influence the creation of dividend strategies, strategic planning, and board composition.

Certain factors decide the magnitude of the DLOC. The most important one is the level of influence the shareholder can have on various decision-making processes. Other than that evaluation companies also consider factors like how vulnerable the shareholder is to various ownership-associated risks. The assessment expert also needs to consider certain conditions unique to different marketplaces.

Liquidity and Marketability: According to experts, liquidity has a strong sway on minority interest valuation. The liquidity of the shares decides how marketable will they be. Privately held shares, which typically have low liquidity, have a much lower selling price compared to publicly traded shares. This automatically diminishes the former’s marketability.

The other factors that have a strong impact on the marketability of minority shares include current market trends, allocation of voting rights, and terms and conditions of shareholder agreements. Voting constraints and share transactions reduce the ability of a minority shareholder to liquidate, which automatically decreases the value of those shares.

The Rights of the Shareholder: One of the first things evaluation experts do is check the agreement detailing the rights of both parties. This happens irrespective of whether it's a life insurance policy valuation or an estate valuation. When evaluating minority interests in a business, the expert doing the job checks and assesses shareholder agreements carefully to comprehend the shareholder’s limitations and rights, which play a crucial role in calculating the exact value of the minority shares.

Shareholder agreements include clauses governing dividend policies, share transferability limitations, voting power, etc. These are factors affecting the value of the shares directly.

Methods Used to Calculate Minority Ownership Interest

DCF: DCF, which stands for Discounted Cash Flow, is the most widely used valuation method for calculating all kinds of partial interests. To complete the process successfully, experts need to accurately project the forthcoming cash flows of the company and calculate their current value. When evaluating minority interests, the experts must adjust the amount based on factors like marketability, lack of control, etc.

To be more precise, the method DCF uses DLOC to present the actual value of a business’s minority interests. The subsequent adjustment is responsible for the shares’ decreased marketability and thereby ensures an accurate and fair valuation.

GPCM: GPCM stands for Guideline Public Company Method. The method is frequently used by the country's evaluation firms. The process involves comparing a business to various publicly traded counterparts and extracting valuation multiples.

When a company’s overall market valuation and financial performance are compared to that of similar public organizations, appraisers get hold of numerous essential benchmarks. They can then use these newly discovered benchmarks to assess the private company they are evaluating.

The biggest benefit of this method is that the estimation it offers depicts market realities. During GPCM, experts obtain data from relevant public companies and use them to evaluate minority interests in a private enterprise. As a result, the appraisal always stays aligned with industry-specific events and existing market forces.

NAV: NAV or Net Asset Value calculates the net worth of a company’s assets and subtracts all possible liabilities from it to find its exact value. When NAV is used to find the value of a particular shareholder’s portion, the evaluation expert subtracts the debts the business has from its assets. NAV is often used to showcase the financial health of a company and let the world know that it has hefty asset holdings.

Final Words

If you want to know the value of your minority ownership interest in a company, you must ensure that you hire a professional to assess on your behalf. That’s because it’s a job best left to experts.

Even with all the information available online, a layman can’t stay up to date with the latest evaluation techniques. It is also impossible to identify which technique will be appropriate for a given situation. If you hire the right company for the job, you will get to hire them for a plethora of services from them as and when required. This includes gift tax valuation, insurance valuation, etc.