Minority Shareholder Discount in Business Valuations During a Divorce
When a business is valued as part of a divorce proceeding, the valuators will often discount the value of the shares the community owns if it owns a minority stake in the business.
Minority Shareholder Discount
The reason for a minority shareholder discount in Business Valuations is because investors are less likely to want to buy a business that they cannot control. This is especially true of most community businesses, which tend to be “closely held businesses,” i.e., they are owned by one person or just a few people. That means an investor buying into a business will likely be at the mercy of the existing owner’s business decisions.
Most people who invest in small businesses are investing in themselves—they believe that they can make the small business successful. But when they buy a minority stake in someone else’s small business, they aren’t betting on themselves; they are betting on the majority owner.
Because the shares of a minority shareholder are less attractive and more difficult to transfer, business valuators understandably discount the value of the shares.
Schickner v. Schickner
A relevant case on this topic is Schickner v. Schickner, 237 Ariz. 194 (App. 2015). The issue in Schickner v. Schickner was whether the minority shareholder discount applied in a situation where the community owned 50% of an ophthalmology business. The trial court determined that, in that instance, a minority share discount was appropriate. The Court of Appeals disagreed and overruled the trial court.
The key fact, in the Court of Appeal’s view, was that Husband exercised substantial control over the business, including the ability to determine his pay and how he would receive it. His ability to control undercuts the rationale of why a minority shareholder discount is applied in the first place.
The Court reasoned that because the minority shareholder discount is intended to “take into account the difficulty of actually turning an asset into money, its application may be inappropriate when the underlying assumptions regarding lack of control and lack of marketability are not supported by the evidence,” Id at ¶ 17.
3 Factors to Determine Minority Shareholder Discount
The Court went on to note that a minority shareholder discount is applied on a case-to-case basis, and the three factors a court can consider when deciding whether a minority shareholder discount should apply are (1) the shareholder’s degree of control, (2) marketability of the shares (i.e., are the shares easy to move), and (3) is a sale likely in the foreseeable future.
If the owner of the business can offer a subsequent seller control, then the shares do not get a minority discount. If a sale of the whole business is foreseeable, that may also negate the need for a discount, presuming the buyer will pay the same for all stocks. If the business is not sold, one must look at the market. Some business interests are easier to sell than others, even if the ownership is just a minority stake.
Bottom Line
The bottom line is that the better the market is for selling your business, the more value it has. When you own a minority share, the market is much harder; therefore, one minority share is not the same value as a majority share, and a minority shareholder discount should be applied to the value.
