Valuing a minority shareholding in an industrial business

How is a minority interest valued?

In two steps. First, the company is valued as a whole: enterprise value from its earnings or cash flows, less debt and debt-like items, plus any surplus assets, to give the value of all the shares. The methods for that step are on how we value industrial businesses. Second, the interest is considered on its own terms: how many shares, what class, what rights they carry, and what the governing documents say about transferring or valuing them.

The pro rata value is the percentage held multiplied by the value of all the shares. The question this article deals with is when a minority interest is worth that amount and when it is worth less.

What does control mean in a private industrial company?

Control is the power to decide what happens to the business and its cash. In a private company it usually means the ability to appoint the board, which in turn decides dividends, capital spending, borrowing, salaries, related-party dealings and whether the business is sold. Under the Corporations Act 2001 (Cth), a special resolution needs at least 75% of the votes cast by members entitled to vote (s 250MA), so a holder of more than a quarter of the votes can block one by voting against it, even without control.

In an industrial business these powers matter more than usual, because the cash decisions are large. A controlling shareholder can put three years of profit into a new CNC cell or a second production line, draw a large salary as managing director, or lease the factory from a family trust. Each decision may be commercially sound. Each also affects whether a minority holder ever sees cash.

Positions in between matter too. A 50/50 company has no controller and can deadlock. A 49% holder with a board seat, information rights and a veto over major capital spending has much of what control provides. The word minority covers a wide range of positions.

What are discounts for lack of control and marketability?

A discount for lack of control reflects that the holder cannot direct the company's decisions or its cash. A discount for lack of marketability reflects that the shares are hard to sell. They are related but different: a controlling interest in a private company can also be hard to sell, and a minority interest in a listed company is easy to sell but carries no control.

Shares in a private industrial company are rarely easy to sell. There is no market for them, outside buyers are scarce, and transfers are restricted. Unless the constitution displaces it, a replaceable rule in the Corporations Act lets the directors of a proprietary company refuse to register a transfer of shares for any reason (s 1072G). Many shareholders agreements add pre-emptive rights, so shares must first be offered to the other shareholders.

We do not publish rule-of-thumb percentages for either discount. The right adjustment, if any, depends on the facts, and ranges drawn from other markets or other purposes are easily misapplied. What a report should set out is the reasoning: which features of this interest support a discount, which reduce it, and why the conclusion follows.

There is also a double counting trap. If the value of the whole company is based on earnings depressed by the majority's above-market salary or related-party rent, applying a full minority discount on top penalises the same problem twice. We normalise those items when valuing the company, then consider what the minority position actually costs the holder.

What does the shareholders agreement say?

Often it decides the answer before any valuation judgement is made. A well-drafted shareholders agreement says how shares are valued when they change hands, and that clause defines what the valuer must value. Common versions include:

• fair market value determined by an independent valuer, with nothing more said
• a pro rata share of the value of the whole company, with no premium for control and no discount for a minority interest
• a formula based on a defined earnings figure or net tangible assets, sometimes set years ago and never revisited
• different bases for different triggers, such as full value on death or disability and a lower value for a bad leaver

The triggers matter as much as the basis. Death, permanent disability, retirement, resignation, dismissal for cause, deadlock and an offer from an outside buyer are commonly treated differently. Drag-along and tag-along rights decide whether a minority holder shares in a sale of the whole company at the same price per share.

Where the agreement is silent, out of date or drafted for a different business, the purpose of the valuation and the applicable law fill the gap, and the report states the basis it adopts so that everyone can see it.

When is pro rata value the right answer?

• The agreement requires it. If the agreement values a departing shareholder's shares as a proportion of the whole company without discount, that is the basis.
• The whole company is being sold. Where all shareholders sell together, or tag-along rights apply, each receives its share of the total price.
• Compulsory acquisition under the Corporations Act. Where Chapter 6A applies, fair value is worked out by valuing the company as a whole, allocating that value among the classes of securities, then allocating each class pro rata without a premium or discount for particular securities (s 667C). It is the clearest statutory statement of the pro rata approach, although most private share transfers fall outside it.
• A court orders a buy-out. Where the conduct of a company's affairs is oppressive, unfairly prejudicial or unfairly discriminatory against a member, or contrary to the interests of the members as a whole (s 232), the court can make any order it considers appropriate, including for the purchase of shares (s 233). The basis of value in a court-ordered buy-out is a matter for the court and for legal advice.

A discounted value is more likely to be relevant where a minority parcel is sold on its own to someone who will not gain control, or where the purpose calls for the market value of that particular parcel rather than a share of the whole. Our shareholder valuation page covers the purposes we see most often.

Why do industrial companies raise particular minority issues?

Reinvestment instead of dividends

Capital-intensive businesses can absorb all of their cash in new equipment, larger premises and working capital for growth. A minority holder in that company may watch value build on paper for years without receiving anything. Whether that lowers the value of the interest depends on whether the reinvestment is sound and whether the holder has a realistic route to an exit.

The factory belongs to the majority

Operating companies often lease their factory from the founder's family trust or self-managed super fund. If the rent is above market, value moves from the company, where the minority shares in it, to the property owner, where it does not. We normalise to a market rent when valuing the company and identify the effect in the report.

Working shareholders

Minority holders in engineering and manufacturing companies are often senior employees: the operations manager, the chief estimator, the engineer who designed the product range. Their shares and their employment are tied together, and leaving the job may trigger a leaver clause with a set basis of value. If key customer relationships or technical knowledge sit with that person, their departure also affects the value of the company itself, which has to be considered when the company is valued at the date they leave.

Personal guarantees

Equipment finance and bank facilities in private industrial companies are often personally guaranteed by the shareholders. A departing minority holder will want to be released. The release is negotiated separately from the share price, but it shapes what a fair overall settlement looks like.

What information can a minority holder obtain?

Minority holders often know less than the majority, which affects both the negotiation and the valuation. Shareholders with at least 5% of the votes in a small proprietary company can direct it to prepare a financial report and directors' report for a financial year and send them to all shareholders. The direction must be signed and given within 12 months after the end of that year, and it can require the report to be audited (Corporations Act s 293). A member can also apply to the court for an order to inspect the company's books, which the court may make if the member is acting in good faith and for a proper purpose (s 247A).

For our part, we need the company's records to value it properly. Where we are engaged by one shareholder without the company's co-operation, we say at scoping what can be done with the information available, and the report records any limitation that results.

What if the shareholders are already in dispute?

A valuation prepared for commercial purposes, such as negotiating a buy-out, is not a court expert report. If proceedings are on foot or likely, expert evidence is a separate engagement with its own scope and fee, as our dispute valuation page explains. Where a property settlement is involved, see family law business valuation.

Many disputes settle once both sides see one independent figure prepared on a basis they have agreed. A jointly instructed valuation under the agreement's own clause is usually faster and cheaper than competing reports. The court's wider powers, including winding up a company where it is just and equitable to do so (s 461(1)(k)), give both sides a reason to find a basis they can accept.

What do we need to value a minority interest?

• The constitution and the shareholders agreement, with all amendments
• The share register, including share classes and their rights
• Three years of financial statements and current management accounts
• Dividend and remuneration history for each shareholder
• Related-party agreements: leases, management fees, loans and guarantees
• Board minutes for major capital, borrowing and remuneration decisions
• Any offers received for the shares or the business

Fees follow our fixed bands, set by the company's annual turnover. Each additional valuation date is $495 + GST and each additional entity is $795 + GST. Contested matters and litigation support: Quoted individually. We confirm the fee in writing before we start. No hourly billing. You can request a fixed-fee quote with the agreement to hand, or see pricing first.