Minority interest. What is it?
A minority shareholding is no more than 49% (ignoring fractions of a shareholding). Think of a it as trading shares on the stock exchange where valuing each shareholding is a minority interest, unless an offer is made in the form of a takeover. Either way the shares are priced at market value through the exchange procedures.
How valuable is a minority interest?
The sale of a minority interest in a private company may have its value adversely affected by the articles of association (the company “rule book”) as the directors’ right of refusal to register a share transfer restricts the marketability. Such restriction are often put in place to keep the shares “within the family” or to avoid the founding shareholders losing control of the company.
If this is the case, the value of a minority interest may be reduced to reflect a lower value than its equivalent share of the company. This can be avoided by the articles of association, or an overriding shareholders’ agreement, stating that all shares are valued on a pro rata basis to the value of the whole company.
What influence does a minority interest shareholder have?
Case law supports a pro rata basis of valuation, which means shareholders start and continue with the company either as working or as ‘sleeping’ member and where it is effectively a partnership in all but name.
Even though a minority interest can be of little influence on the management of the company, an acquisition by an existing member can alter the scales of power within the company, if it makes the buyer a majority shareholder as a result. In this case the buyer would be sensible not to insist on too much of a discount on the minority interest.
What about dividends for minority interest shareholders?
Since a minority shareholder is not able to decide on directors’ remuneration or influence the management of the company and the amount of dividends payable, the valuation of the shareholding may be limited to its dividend yield.
In this case the only income a minority shareholder is entitled to is its share of dividends, therefore the valuation is limited to a multiple of the dividend, known as the dividend yield. The dividend yield for a public company is usually between 2% and 5%. Because of less resources and the greater risks involved for a private company, the dividend yield is usually between 10% and 30%.
When valuing share interests or transactions for taxation purposes, tax law only considers the shares under consideration as bought and sold between a “willing buyer” and a “willing seller”. It does not consider the resultant effect on existing shareholders. As a result, there is a discount on a sliding scale made by HMRC to the valuation to recognise the influence that a particular shareholding being sold or transferred may have.
If you have a minority interest in a company or have shareholders with a minority interest within your business and have concerns or questions in relation to valuing minority interests, you are welcome to contact David Cane. David Cane of Sundial Tax & Finance Ltd.