M&A Vocabulary – Understanding the experts: “Discount for Lack of Control, Control Premium”

A “control premium” is defined as an amount or percentage by which the pro rata value of a controlling interest exceeds the pro rata value of a non-controlling interest in a company, reflecting the power to direct management.

Conversely, an amount or percentage deducted from the pro rata value of a 100% ownership interest in a company to reflect the absence of some or all control rights is defined as a “discount for lack of control”.

Large blocks of shares are often transferred at different prices than individual shares in the daily trading of capital markets on the stock exchange. These relative price differences can be significant if the change of ownership of the shares leads to a change of control, such as exceeding 50 percent of the voting rights. In such a case, a potential buyer may be willing to pay a higher price for the company shares than would result mathematically if the equity value of the entire company were broken down to the number of shares included in the transaction. The difference between the quoted market price of a share on the stock exchange and the transfer price of the control-granting shares can – at least in part – be attributed to such a Control Premium for the acquisition of the company’s management control.

For example, a company has two shareholders with 80 percent and 20 percent of the shares, respectively. If the equity value of the company is 10 million euros, a reasonable buyer for 20 percent of the shares will generally not be willing to pay a price of 2 million euros for them. The discount in difference to the 2 million euros constitutes – in part – the Discount for Lack of Control.

Control Premium and Discount for Lack of Control in Acquisitions

Add-on acquisitions or takeover bids can lead to premiums on the equity value or stand-alone value of the shares to be acquired due to synergistic reasons or rationalizing perspectives. For the potential buyer, it may be valuable to assess before a transaction whether a premium actually constitutes a Control Premium or rather:

• represents a premium for synergy effects,
• includes aspects regarding the marketability of the shares,
• includes access to valuation-relevant information, or
• considers the quality of this information
• or perhaps simply represents an overpayment by the acquirer to encourage as many shareholders as possible to accept the offer.

Articles of association or shareholder agreements of unlisted companies can clarify the value at which the main shareholder can exercise their pre-emptive right. Concrete value definitions of the transaction price can limit or clarify the arbitrariness in the Discount for Lack of Control.

Studies show that the amount of the Control Premium depends on factors such as industry sector, time, and the type and size of the transaction, while company size does not appear to be a influencing factor. Furthermore, a tendency has been observed for the Control Premium to be significantly higher in market-oriented countries, where companies are financed to a greater extent via the capital market, than in bank-oriented countries.

The amount of the Control Premium varies depending on which and how many control characteristics are included, as well as the added value the acquirer can realize through their structuring options for increasing the company’s value.

Conclusion

In transactions involving blocks of shares that lead to a transfer of corporate control, the monetary quantification of the Control Premium can represent a significant portion of the transaction price.

The economic understanding of distinguishing the Control Premium from other possible premiums or discounts enhances the quality of the offer in connection with calculating the benefit of the shares to be acquired for the buyer.

Likewise, the Discount for Lack of Control is an important aspect for minority shareholders when it comes to understanding the value of shares in consideration of definitions in shareholder agreements. Minority shareholders of a company should clearly define the valuation method in a shareholder agreement to understand the possibility of considering a minority discount when selling their shares. This is because contractual provisions for share disposal can significantly influence the valuation in their definition.

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