Factors Affecting Discounts in Valuing Asset-Holding Companies By Sharon F. Foote, ASA CFE
Posted on December 30, 2013
Asset-holding companies are generally described as entities that possess assets such as real estate, marketable securities, notes or loans receivable, and/or interests in other entities. These entities may take the form of a corporation (S or C), a limited liability company, a general partnership or a limited partnership.
Valuation professionals are often asked to determine the value of fractional interests in asset-holding companies. These entities are commonly structured with a general partner, managing member or voting shareholder who has a small percentage ownership interest as well as exclusive control of the day-to-day business of the enterprise. The limited partners, non-manager members or nonvoting shareholders lack the ability to control the management, acquisition or disposition of the entity’s assets or the distribution of its profits and capital gains. Neither do they have the ability to liquidate or dissolve the entity. Therefore, the valuation of these fractional interests would qualify for a Discount for Lack of Control (DLOC).
The time and effort required to transfer these fractional interests and the lack of a ready market, are reflected in the application of a Discount for Lack of Marketability (DLOM).
In addition, there are other factors that must be considered when determining of the size of the discounts for lack of control and marketability.
- The specific size of the ownership interest being valued and the bundle of rights attached to the ownership of the interest. These are commonly set forth in the entity’s operating agreement, shareholder agreement, by-laws or other governing document
- The transfer restrictions typically imposed in the operating agreements of these asset-holding companies
- The ownership structure of the entity being valued
- The size and the diversification of the assets owned by these entities. Asset-holding entities are typically much smaller and less diversified in their holdings than similar publicly traded entities.
- The amount of debt and equity the entity uses to support and grow its operations. For example, an interest in an entity with significantly more debt than equity would be considered highly leveraged, riskier and would likely sell at a higher discount.
- The level and stability of the earnings generated by these entities. Businesses with higher profits or stable earnings would likely sell at a lower discount, as these factors mitigate some of the risk of these investments.
- The level and frequency of distributions to owners affect discounts; an entity that has consistently distributed a significant amount of its earnings would sell at a lower discount as the owners are receiving a return on their investment before its liquidation or dissolution.
- The expected holding period of the investment – the ending date of the entity may be specifically identified, or may be identified as perpetual, in the formation documents.
- The state of the industry as well as the national, local and/or regional economies in which the entity participates.
It is also important to remember that asset-holding entities typically do not have the same level of professional management as a publicly traded entity may possess.
The extent to which a valuator takes a Discount for Lack of Control (DLOC) may also be affected by the methodology used in valuing the subject interest. The DLOC determined under the Adjusted Net Asset Value Method will be higher than that determined under some other methods as it is based on the current market values of the assets and liabilities of the entity on a controlling basis.
Under a Market Approach, Price to Net Asset Value ratios of noncontrolling interests in similar publicly traded closed-end funds and/or real estate limited partnerships are utilized to estimate a value of the assets in the entity being valued. The Income Approach uses cash flows available to noncontrolling interests and a capitalization or discount rate based on returns in the public market to minority owners. Accordingly, no additional DLOC may be warranted under the market or income approaches.
It is widely recognized that there is some overlap of the lack of control and lack of marketability discounts in the studies used to quantify these discounts, which is also taken into consideration when determining the size of the discounts taken in valuing interest in an asset-holding company.
The bottom-line question – “How big a discount from net asset value can you get me?”- often depends on the specific facts and circumstances of the situation. The valuation team at Berkowitz Pollack Brant has experience in conducting valuations in different types of scenarios.
About the Author: Sharon Foote ASA CFE is a manager in the Valuation and Litigation Support practice of Berkowitz Pollack Brant. For more information, call (305) 379-7000 or e-mail firstname.lastname@example.org.