Minority Discounts: Defend Them or Lose Them

By Jerry Barney Tuesday, May 5, 2009

Minority Interests are Worth Less Than Control Interests. It is simply a fact that minority interests in closely held companies are worth less, pro rata, than control interests.  Minority interests are usually considered to be 50% or less.  In appraisal terms this is the difference between Fair Value, and Fair Market Value.  To illustrate the point, what would, say, a 10% interest in a closely held C-corporation be worth if the owner decided to try to sell it to a public buyer?   The appropriate value would be Fair Market Value.  The answer: not much.  It likely pays no dividend.  The only chance to recover the principal investment is upon sale of the entire company, and the minority shareholder likely has no control in that regard.  Therefore the Fair Market Value of the minority interest would reflect a fairly deep discount from Fair Value – perhaps as high as an 85% discount depending on the circumstances.  The size of the discount is dependent upon the impairments to control of marketability contained in bylaws, shareholder’s/partnership agreements, buy-sell agreements, etc.

This fact can be used to advantage to reduce taxes in gifts or transfers of interests as a part of estate planning.  However these discounted values must be supported by a qualified appraisal.

What Recent Court Cases Have Shown: Cases brought to the Tax court in recent years have shed light on the relatively obscure subject of discounted values caused by reduced marketability and control for minority interests.

Prior to these cases, appraisers typically treated valuation of such discounts as a minor adjunct to the valuation of the basic (majority interest) position.  Many either used “industry standards” for marketability discounts of, say, 35% without support, or they attempted to support these values with statistics from studies of restricted stock of public companies.  The courts have rejected such valuations in closely held securities, and laid down some principles which, if adhered to in appraisals, should significantly limit the chances of litigation and in many cases, significantly increase the defensible size of the discount.

Full Analysis Required. Though the appropriateness of applying minority discounts has been universally accepted by the IRS and the courts, recent court decisions have shown a fair amount of disagreement over the means of quantifying them.  IRS Revenue Ruling 77-287 deals with marketability discounts for “restricted securities,” but it is silent on “exempted securities,” which make up the vast majority of privately held securities.)  The cases indicate a complete analysis is required to effectively defend the discount!  The cases also clearly indicate that reliance on data from public company transactions is not appropriate for closely held, exempt, non-registered securities.  (stocks, partnership interests, LPs, and LLCs are all securities under the law.)

Lack of Control Discounts, for small privately held companies are magnified in comparison with publicly held companies for a simple reason – in privately held companies the only practicable way to recover the investment is liquidation (sale) of the company.  Without control, an investor does not have the right to exercise this option.  Thus minority interests in closely held companies are very difficult to sell.  In practice, appraisers have attempted to base discounts for lack of control on control premium studies of public companies.  The two are not the same at all.

The case of Mandelbaum v. Commissioner, T.C.M 1995-255 sets forth basic factors which might comprise the discount, but this list was not exclusive, and other factors may apply and be considered as the situation dictates.  It states that a complete analysis must be done which is relevant to the subject. In principle, the analysis must address all relevant factors.  It includes but is not limited to issues such as private vs. public sales of stock, dividend policy, economic outlook, management, control issues and policies, voting rights, restrictions on transfer, redemption or “put” policy, etc.

Control Discounts as Applied to Family Members Owning Shares. IRS Revenue Ruling 93-12 holds that a minority discount will not be disallowed (emphasis added) solely because a transferred interest, when aggregated with interest held by family members, would be part of a controlling interest.

Conclusion: The courts have indicated that the appraiser must conduct a complete, defensible analysis of the applicable issues upon which to base his decision.

More Information. A white paper which provides more detail on minority and control discounts  including court case references can be accessed at:

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