Quick Read: Discounts, Discounts, Discounts!

“The whole is greater than the sum of its parts” – Aristotle

 In valuation theory, this quote generally refers to the concept of synergy whereby combining individual businesses, segments, or operating lines of services can result in a more valuable enterprise.

 The converse, however, can also be true in certain situations where adjustments or discounts are necessary to arrive at a reasonable conclusion regarding the value of certain business entities.

 The theory of valuation is based on estimating or opining upon a theoretical transaction price that would likely occur in the “real-world”. Flowing from real-world observations comes the requirement to apply adjustments, often significant ones, to reflect a theoretical buyer’s perceived discounts attributable to a variety of causes including the following:

1. Income Taxes

In some cases, the value of an entity must be adjusted (either higher or lower) to reflect tax considerations that could include:

• Loss carry forwards (generally increases value);
• Latent taxes associated with assets (often real estate) whose current value is in excess of its adjusted cost base for tax purposes; and
• Unavailable capital cost allowance on depreciable assets (often buildings) owned by a corporation that cannot be “bumped up” for tax purposes.

2. Minority or Liquidity Discounts

These discounts are typically considered when the ownership interest being valued is less than or equal to 50% of the entity. These discounts reflect the disadvantages associated with not being able to control a business, including:

• The inability to dictate dividend payments, partner distributions or other compensation;
• The inability to make autonomous business decisions including a sale of assets;
• The increased difficulty of obtaining financing on non-controlling ownership interests; and
• The lack of liquidity associated with selling a minority interest.

3. Conglomerate/Portfolio Discounts

Conglomerate/portfolio discounts reflect the reality that a potential purchasers of certain entities may desire some of the entity’s assets but not all. This discount has often been studied in publicly traded companies which often trade on the market at a discount to their break-up values.

 Another example could be found in certain real estate entities that own dissimilar assets with varied locations and/or types of properties (i.e. residential, commercial, retail, etc.). Finding a buyer for the specific collection of properties could be difficult and a discount may be required to entice a theoretical purchaser to purchase the entire entity.

We purposely have not provided any comments on the specific quantum of the various discounts noted above because, in our opinion, rules of thumb or generalizations are likely not meaningful because of the unique attributes associated with any particular valuation matter. It is critical, however, to be sensitive to these applicability of these potential discounts so that proper conclusions can be arrived at when valuing businesses.

There may be other adjustment (pos or neg) that may be applicable that have not been canvased above. If you wish to discuss any particular issue that you or your clients may have, please do not hesitate to call or email us. In the meantime, best wishes to you, your families and your colleagues for health and safety.

For more information, please contact Wayne B. Rudson, CPA, CA·IFA/CBV, ASA, CFE ([email protected]) or Vincent Lam, CBV, MAcc ([email protected]) at 416-598-4500.