Quick Read: Does Family Control Mean No Minority Discounts? Not Necessarily.

One of our earlier Quick Reads reviewed the appropriateness of applying discounts to allocable ‘en bloc’ fair market value regarding a non-controlling, minority interest. Such discounts exist to reflect the understanding that actual or theoretical purchasers require a reduction in price to reflect the disadvantages of non-controlling interests.

The applicability of a minority or liquidity discount is, however, often negated in cases where minority shareholders are related as a family and can thus exercise “family control” if they were to act in unison or in a generally cooperative manner unlike cases of non familial shareholders.

The general presumption of family control resulting in the non-applicability of a minority or liquidity discount, however, is just that, a proposition, and is not always the case.

Ben Rosenhek of our office has provided the following discussion in this area.

Minority Discounts - a Brief Refresher

In valuing a minority interest, several factors are typically considered when arriving at an appropriate discount or discounts, such as:

1. Reduced Managerial Control: Inability to elect the board of directors, dictate dividend or similar payments, authority to determine major asset sales or redevelopment, etc.
2. Financing Hurdles: Increased difficulty in securing financing for non-controlling ownership interests.
3. Liquidity Challenges: The inherent difficulty in selling a minority interest to a purchaser who will have to assume all the disadvantages of a minority shareholder agreement, including further restrictions in shareholders agreements etc.

While the amount of discount is completely dependent of the circumstances of an individual matter, such discounts can range from a few percentage points up to 30 to 40% in some cases.

Minority Discounts in Cases of Family Control

Family control situations are unique because individual minority shareholders who are related to each other and comprise a “control block” are generally presumed to function in concert and in a manner that considers other family members in a preferential way unlike in the case of non-arm’s length minority shareholders.

There is a general presumption that minority discounts are not applicable to minority shareholdings. This presumption is manifested in two authoritative places, as follows:

1. CRA generally does not permit the application of a discount to a minority shareholding in cases of family control as articulated in Information Circular 89-3 which states the following:“In a situation where the existence of family control is recognized, the Department will employ a rateables valuation for each family group member’s shares.”
2. In many, if not most cases, of family control the courts also appear reluctant to apply minority discounts as illustrated by the following examples:

There are, however, exceptions to this presumption of family control and the inappropriateness of minority discounts. In some cases, minority discounts may still be appropriate even in cases of family control, particularly if there is evidence of discord amongst the family members. There may be general discontent or, even in some cases, actual or threatened litigation negating the presumption of family cooperation.

In these cases, family members may act as if they are arm’s length individuals and not in concert when deciding major operational matters (e.g. renovations, asset sales, expansion decisions, etc.) or dictating dividend/profit distribution policies, etc.

We are aware of certain court cases where minority discounts have been applied in family control situations as illustrated by the following examples:

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We are not aware of any income tax cases where discounts have been applied to minority shareholding in cases of family control although we see no reason why income tax cases should be considered any different than the other cases discussed above.

As we have communicated in previous Quick Reads, the application of discounts in the valuation of a particular shareholding is complicated and must consider not only minority situations but also inherent income taxes, conglomerate discounts, portfolio discounts etc. The existence of family control in the valuation of a minority interest does not automatically require the valuation conclusion to be based strictly on allocable share of ‘en bloc’ fair market value as there will be circumstances where minority or other discounts may be appropriate. The facts in each case will assist the business valuator in determining what discounts should be applied.

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For more information, please do not hesitate to contact Wayne B. Rudson, CPA, CA·IFA/CBV, ASA, CFE ([email protected]), Vincent Lam, CBV, MAcc ([email protected]), Ben Rosenhek ([email protected]) at 416-598-4500.