Business valuation - discount and premium controversies

Within the business valuation profession, discounts and premiums are an ongoing source of controversy. But why?

What are discounts and premiums?

Firstly, what are discounts and premiums? The International Valuation Standards state that:

"In the market approach, the fundamental basis for making adjustments is to adjust for difference between the subject asset and the guideline transactions or publicly-traded securities.", some of the most common adjustments are know as discounts and premiums.[1]

Per the International Standards, for example [1]:

Control Premiums and Discounts for Lack of Control (DLOC), are applied to reflect differences between the comparables and the subject asset with regard to the ability to make decisions and the changes that can be made as a result of exercising control.

The International Standards, however, do not provide any guidance on how to apply discounts and premiums.

What are the elements of discounts and premiums?

The American Society of Appraisers Standards provide slightly more insight in the application of discounts and premiums. The Appraisers Standards set out key elements of discounts and premiums, including that [2]:

1. a discount and a premium has no meaning until the conceptual basis underlying the base value to which it is applied is defined;
2. a discount or premium is warranted when characteristics affecting the value of the subject interest differ sufficiently from those inherent in the base value to which the discount or premium is applied; and,
3. a discount or premium quantifies an adjustment to account for differences in characteristics affecting the value of the subject interest relative to the base value to which it is compared.

Three key steps in applying discounts and premiums

Based on my interpretation of the Appraisers Standards, there appear to be three key steps to applying discounts and premiums:

1. define the comparative base value;
2. define the different characteristics between the base value and the subject value; and,
3. quantify the difference and obtain support.

Each of these steps appears to be a potential source of controversy.

Base definition controversies

Per the International Valuations Standards, the two key base values implied in the market approach are:

1. publicly-traded shares; and,
2. guideline transactions.

Publicly-traded shares are often referred to as a base of value that reflects minority interest values, because, public company share prices reflect transactions in small parcels of shares and the share holders often do not have the ability to make decisions related to the operations of the company. Using publicly-traded shares to value a subject control interest will surely require the application of premium to reflect control.

The problem is, according to Eric Nath, publicly-traded shares do not really act like minority interests. They are highly liquid. If all publicly-traded companies traded at a discount why are they not all taken over? [3]

Guideline transactions often relate to the acquisition of control. Using guideline transactions to value a subject minority interest surely will require the application of a discount to reflect a lack of control.

The problem is, guideline transactions often have a lot of baggage attached. Transaction prices may reflect premiums paid for synergies, deferred consideration, and inflated egos!

Characteristic definition controversies

Characterises are seemingly easily to discern. A controlling interest provides the investor a plethora of advantages such as control of business strategy, control over operational efficiencies and control over dividend distribution.

The elements of control are clearly advantageous. They can increase cash flow. Increasing cash flow increases value.

However, isn't one of the roles of a CEO of public company to seek to maximise shareholder value, through good business strategy, operational efficiencies and optimal dividend distribution? If all public companies are not being run optimally why are they not all taken over?

Support controversies

Often valuers refer to academic studies to support and quantity discounts and premiums, for example, control premium studies and restricted stock studies.

These studies provide observed evidence of the apparent existence of discounts or premiums in the market. The valuer can adopt the average from the study to legitimately support the premium or discount.

The problem is that the studies often have a significant variation in the data which renders the averages potentially meaningless.

Summary

Discounts and premiums provide an established approach to infer value. However, it appears that the approach requires that the base and characteristic differences are accurately defined and that the support is statistically correct.

Simon Cook

Simon specialises in wrestling with and attempting to pacify often complex valuation problems. He is a Chartered Accountant Business Valuation Specialist with Chartered Accountants Australia and New Zealand (CA ANZ). He chairs the CA ANZ Business Valuation group for Queensland, is a member of the CA ANZ Trans-Tasman Business Valuation Committee and likes running long distances in the muddy hills!

[1] 2025 International Valuation Standard 103, paragraph A10.17.

[2] American Society of Appraisers Business Valuation Standard VII, Valuation Premiums and Discounts.

[3] Eric Nath, Control. premiums and minority interest discounts in private companies (June 1990) Business Valuation Review.