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FVLE Issue 19 June/July 2009 Page 4
FINANCIAL VALUATION - Discounts
GILBERT E. MATTHEWS, CFA &
MICHELLE PATTERSON, JD, PhD
Sutter Securities Incorporated
San Francisco, CA
gil@suttersf.com
Testing for an ‘Implied
Minority Discount’ in
Guideline Company Prices
Delaware has developed a large body
of case law interpreting the Delaware
statute’s appraisal standard in dissent-
ing shareholder cases. The appraisal
statute states, “[T]he Court shall deter-
mine the fair value of the shares exclu-
sive of any element of value arising
from the accomplishment or expecta-
tion of the merger or consolidation,”1
which gave rise to the appraisal pro-
ceeding. Fair value is to be ascertained
on a “going-concern” basis.
Unfortunately, when Delaware
Chancery Court appraisal decisions
have applied the guideline company
method, the court has often incorporat-
ed the concept that guideline company
valuations should be adjusted upward
to offset a presumed “implied minori-
ty discount” (“IMD”).2The Court has
accepted the assumption that the mar-
ket prices of publicly traded shares
represent minority interests. As Vice
Chancellor Leo Strine put it:
The comparable companies analy-
sis generates an equity value that
includes an inherent minority
trading discount, because the
method depends on comparisons
to market multiples derived from
trading information for minority
blocks of the comparable compa-
nies. In a [Delaware] appraisal,
the court must correct this minor-
ity trading discount by adding
back a premium designed to off-
set it.3
This article addresses the
Delaware Court’s misapplication of
control premiums from a business val-
uation perspective.4It focuses on why
it is inappropriate to assume that the
market prices of guideline companies
necessarily include an IMD. A method
is proposed whereby the valuator, in
any specific valuation, can ascertain
whether implied minority discounts
exist in the relevant guideline compa-
ny prices.
LEGAL COMMENTATORS
HAVE DISAGREED WITH THE
CHANCERY COURT’S POSITION
Several significant law journal articles
have rejected the theory that market
prices always include an implied
minority discount that must be added
back when calculating the “fair value
of the shares.” In 2001, Professor
Richard Booth wrote, “[I]t is not neces-
sarily the case that actual market price
is always less than fair market price. If
it were, then there would be no such
thing as a fair market price.”5
Professor William Carney also
argued that market prices of most pub-
licly traded shares do not include a sig-
nificant IMD:
[C]ontrol premiums only occur in
transactions involving a transfer
of control, where there are
thought to be gains from trade. . .
Even if all values, both present
and potential, are valued in the
market price for the firm’s shares,
one would not expect to find a
discernible control premium in a
widely held firm that is well man-
aged and appears to offer little
probability of a transfer of control.
Any small probability of a control
transaction will already be reflect-
ed in the market price, because
absent a dominant shareholder,
all shareholders expect to have an
equal opportunity to share in any
such premium, should it appear.
Absent an actual transfer of con-
trol, control premiums represent
probabilities of a control transfer
at a premium. Where the proba-
bility is close to zero, so is the pre-
mium.6
In order to determine the
amount of adjustment for the premi-
um, Delaware decisions have relied on
average premiums in acquisitions.
Professors Lawrence Hamermesh and
Michael Wachter question this
approach and argue that acquisition
premiums do not support the assump-
tion that market prices necessarily
include IMDs.
[I]t is incorrect to make the logical
jump that these premiums [paid
in acquisitions] reflect some kind
of IMD. The fallacy is obvious
and analogous to the “dogs that
don’t bark” metaphor: there are
lots of dogs, and most of the time,
most dogs are not barking.
Similarly, in any given year, the
vast majority of companies are not
involved in a change of control
transaction.7
They point out that generally accepted
financial theory assumes that market
prices of liquid securities in informed
markets represent going-concern
value. They add, “There is no evidence
that such [market] prices systematical-
ly and continuously err on the low
side, requiring upward adjustment
based on an “implicit minority dis-
count.”
Continued on next page
expert
TIP
Premiums (if any) to adjust for
implied minority discounts
should be determined by com-
paring multiples of guideline
companies to multiples of
acquisitions.
FVLE Issue 19 June/July 2009 Page 5
FINANCIAL VALUATION - Discounts, continued
FINANCIAL WRITERS HAVE
CONCLUDED THAT PRICES OF
GUIDELINE COMPANIES OFTEN
DO NOT INCLUDE AN IMD
It is incorrect to assume that market
prices of guideline companies always
include an IMD. Publicly traded
shares may trade higher or lower than
their pro rata portion of the equity
value of the entire company. There are
numerous periods when shares of
companies in some industries have
traded at higher prices than any
prospective cash acquiror would pay
for the entire business. A notable
example is the “dot.com” phenomenon
in the late 1990s. Internet-related
shares in the late 1990s commonly
traded at prices well above financial
control value. Therefore, Internet com-
panies were seldom bought for cash,
but were acquired through stock-for-
stock mergers with other Internet com-
panies.
In 1990, Eric Nath was the first to
question whether publicly traded
share prices included an implied
minority discount. His position ques-
tioned the conventional wisdom and
argued that market prices generally
incorporated control value. His then-
controversial view was that a compa-
ny’s financial control, positives or neg-
atives, were already reflected in its
freely traded market prices.8
Professor Bradford Cornell
wrote in 1993:
The fact that most companies do not
receive takeover bids at premiums
above market price indicates
investors believe that the shares of
those companies are not worth
significantly more than market
price [emphasis in original].9
In a 1999 article, Shannon Pratt stated,
“Valuation analysts who use the guide-
line public-company valuation method
and then automatically tack on a per-
centage ‘control premium’ … had bet-
ter reconsider their methodology.”10
Mark Lee pointed out in 2001:
If there is no M&A market avail-
able to sell a company at a premi-
um to its stock market value, then
there is little or no acquisition pre-
mium, much less a “theoretical”
premium based on an
average of acquisitions
of dissimilar compa-
nies.11
Pratt quoted Lee’s 2001
article and added, “[I]t is
obvious that, given the
current state of the
debate, one must be
extremely cautious about
applying a control pre-
mium to public market
values to determine a
control level of value.”12
Lee further point-
ed out in a book chapter
in 2004 that “the acquisi-
tion value of a company
may be equal to or below
its market value.” He wrote, “While a
company may be viewed as very
attractive to a purchaser of a minority
interest in the public market, the com-
pany as a whole may be perceived as
too risky at its publicly traded market
price.”13 In the same book, Matthews
pointed out that when “acquisition
multiples in contemporaneous transac-
tions are at the same level as market
multiples, it makes sense for the ana-
lyst to conclude that no [IMD] is war-
ranted.”14 Philip Clements and Philip
Wisler agreed in their fairness opinion
book, stating, “The control value of a
company may not differ greatly [from]
and may even be below its publicly
traded minority share value.”15
Although Chris Mercer had dis-
agreed with Nath in the early 1990s, he
later came to agree with him. Mercer’s
2004 book The Integrated Theory of
Business Valuation16 included a modi-
fied levels-of-value diagram that
showed “Marketable Minority Value”
overlapping “Financial Control
Value,”17 illustrating his view that the
difference between financial control
value and marketable minority value
could be zero. He commented that
“unless there are cash flow-driven dif-
ferences between the enterprise’s
financial control value and its mar-
ketable minority value, there will be no
(or very little) minority interest dis-
count.”18
Over the past 20 years, Nath, Lee
and Matthews have often criticized
the use of average acquisition premi-
ums as a fairness standard.20 Average
acquisition premiums paid for shares
of publicly traded companies are sta-
tistically biased because they only
include companies that were attractive
to acquirors and do not include unat-
tractive or overpriced companies.
Therefore, average control premium
comparisons are often a misleading
measure in valuations. As Pratt
observed in 2001:
Out of the tens of thousands of
public companies only a small
percentage actually are acquired
each year. In recent years the
companies purchased have often
been “best of breed,” making
them a very unique subset of the
market. Statistically, it is unlikely
that this small, select group is uni-
versally representative of the mar-
ket as a whole.21
HOW TO TEST FOR IMD AND,
IF APPROPRIATE, QUANTIFY IT
An implied minority discount is fact-
specific in each valuation, and it cannot
be determined by using a generic rule
of thumb.19 The default assumption
ought to be that no IMD should be
applied unless there is specific data
that indicates otherwise. The fact that
some companies have been acquired at
Continued on next page
FVLE Issue 19 June/July 2009 Page 6
FINANCIAL VALUATION - Discounts, continued
a premium over market price does not
demonstrate that all guideline compa-
ny prices include IMD. The key factor
to be considered is the relation
between market multiples and transac-
tion multiples. Although average
acquisition premiums are a poor stan-
dard, there is meaningful data to be
found in guideline acquisitions— the
multiples paid in those guideline
acquisitions. When there is an absence
of recent guideline acquisitions, that
absence in itself evidences that market
prices of the guideline companies are
not at levels that are attractive to
acquirers. In that situation, no IMDs
would be applicable to that guideline
company valuation.
In the situation where guideline
acquisition data is available, the multi-
ples should be compared to multiples
of the guideline companies. If the
guideline acquisition multiples (appro-
priately adjusted to eliminate syner-
gies and market timing) exceed multi-
ples of guideline companies, that fact
indicates that the application of an
IMD should be considered, and the dif-
ference in multiples provides a basis
for its quantification. As part of the
process, the valuator should consider
what adjustment should be made to
multiples of guideline transactions to
eliminate any synergistic benefits
excludable in a Delaware appraisal (or
in other jurisdictions with appraisal
standards similar to Delaware’s).
Additionally, adjustments may be
required for transactions that were
priced at earlier dates under different
market conditions, especially for valu-
ations in today’s depressed market.
CONCLUSION
It is clear that leading legal and valua-
tion commentators have concluded
that there is no basis for assuming that
market prices of all publicly traded
shares include an implicit minority dis-
count. The default assumption should
be that publicly traded shares sell at a
company’s going-concern value. The
valuator must determine in any given
situation whether or not the guideline
companies should be adjusted for
IMDs. If an analyst con-
cludes in a given situation
that an IMD is appropriate,
its magnitude should be
based on a comparison
between market multiples
and appropriately adjusted
acquisition multiples. F
APPENDIX
Delaware Cases in which
an adjustment was made
for IMD:
Hodas v. Spectrum Technology, Inc., 1992 Del.
Ch. LEXIS 252 (Dec. 7, 1992).
Kleinwort Benson Ltd. v. Silgan Corp., 1995
Del. Ch. LEXIS 75 (June 15, 1995).
Borruso v. Communications Telesystems Int’l,
753 A.2d 451 (Del. Ch. 1999).
Bomarko, Inc. v. Int’l Telecharge, Inc., 794
A.2d 11615 (Del. Ch. 1999); affd. Int’l
Telecharge, Inc. v. Bomarko, 766 A.2d 437
(Del. 2000).
Agranoff v. Miller, 791 A.2d 880 (Del. Ch.
2001).
Doft & Co., Inc. v. Travelocity.com, Inc., 2004
Del. Ch. LEXIS 75 (May 21, 2004).
Lane v. Cancer Treatment Centers of America,
Inc., 2004 Del. Ch. LEXIS 108 (July 30, 2004).
Prescott Group Small Cap, L.P. v. Coleman Co.,
2004 Del. Ch. LEXIS 131 (Sept. 8, 2004).
Dobler v. Montgomery Cellular Holding Co.,
2004 Del. Ch. LEXIS 139 (Oct. 4, 2004); aff’d
in part, rev’d in part on other grounds,
Montgomery Cellular Holding Co. v. Dobler,
880 A.2d 206 (Del. 2005).
Andaloro v. PFPC Worldwide, Inc., 2005 Del.
Ch. LEXIS 125 (Aug. 19, 2005).
18 Del. Code Ann. tit. 8, §262(h).
2The IMD is sometimes called an "inherent minority dis-
count" or an "implicit minority discount."
3Agranoff v. Miller, 791 A.2d 880 (Del. Ch. 2001) at 892.
4This issue is discussed in more detail in: Gilbert E.
Matthews, "Misuse of Control Premiums in Delaware
Appraisals," Business Valuation Review, Summer
2008.
5Richard A. Booth, "Minority Discounts and Control
Premiums in Appraisal Proceedings," 57 Business
Lawyer 127, p. 130.
6William J. Carney & Mark Heimendinger, "Appraising
the Nonexistent: The Delaware Courts' Struggle with
Control Premiums," 152 U. Pa. L. Rev. 845 (2003), p.
860.
7Lawrence A. Hamermesh & Michael L. Wachter, "The
Short and Puzzling Life of the 'Implicit Minority
Discount' in Delaware Appraisal Law," 156 U. Pa. L.
Rev. 1 (2007), p. 33.
8Eric Nath, "Control Premiums and Minority Interest
Discounts in Private Companies," Business Valuation
Review, June 1990, p. 43.
9Bradford Cornell, Corporate Valuation (McGraw Hill,
1993), p. 243.
10 Shannon P. Pratt, “Control Premiums? Maybe, Maybe
Not - 34% of 3rd Quarter Buyouts at Discounts,”
Business Valuation Update, January 1999, pp. 1-2.
This article is cited in Pratt, Reilly and Schweihs,
Valuing a Business, The Analysis and Appraisal of
Closely Held Companies, Fourth Edition (McGraw Hill,
2000), p. 357.
11 M. Mark Lee, "Control Premiums and Minority
Discounts: the Need for Economic Analysis," Business
Valuation Update, August 2001, p. 4.
12 Pratt, Business Valuation Discounts and Premiums,
2001, p. 40.
13 M. Mark Lee, "The Discount for Lack of Control and
the Ownership Control Premium," in The Handbook of
Business Valuation and Intellectual Property Analysis,
Robert F. Reilly and Robert P. Schweihs, eds.
(McGraw Hill, 2004), p. 37.
14 Matthews, "Fairness Opinions: Common Errors and
Omissions" in The Handbook of Business Valuation
and Intellectual Property Analysis, p. 215.
15 Philip J. Clements and Philip W. Wisler, The Standard
& Poor's Guide to Fairness Opinions (McGraw Hill,
2005), p. 94.
16 Z. Christopher Mercer, The Integrated Theory of
Business Valuation (Peabody, 2004). This book and
its next edition (Mercer and Travis W. Harms, Business
Valuation: An Integrated Theory, Second Edition (Wiley,
2007) innovatively show the interrelation among vari-
ous approaches to valuation, discounts and premiums.
17 Id., p. 110.
18 Id., p. 108.
19 The U.S. Tax Court now requires case-specific analy-
ses and rejects generic discounts for lack of mar-
ketability. See Mandelbaum v. Commissioner, T.C.
Memo 1995-255 (1995); Pratt, Valuing a Business,
Fifth Edition, (McGraw Hill, 2008), p. 449; Michael A.
Paschall, “The 35% ‘Standard’ Marketability Discount:
R.I.P,” CCH Business Valuation Alert, Feb. 2005, p. 3.
20 See, e.g., Nath, pp. 41-43; Matthews and Lee,
"Fairness Opinions & Common Stock Valuations" in
The Library of Investment Banking, Vol. IV, R. Kuhn,
ed. (Dow Jones Irwin, 1990), p. 407; Lee and
Matthews, "Fairness Opinions" in The Handbook of
Advanced Business Valuation, Reilly and Schweihs,
eds. (McGraw Hill, 2000), p. 327; Lee, "Control
Premiums and Minority Discounts: the Need for
Economic Analysis," Business Valuation Update,
August 2001, pp. 2-4; Lee, “The Discount for Lack of
Control and the Ownership Control Premium,” p. 43;
Matthews, "Fairness Opinions: Common Errors and
Omissions," pp. 214-6.
21 Pratt, Business Valuation Discounts and Premiums,
2001, p. 60.
