Nuances with Respect to Valuing a Controlling Ownership Interest

A controlling ownership interest typically commands a premium because it allows owners to influence business decisions and increase cash flow. However, organizational documents sometimes grant noncontrolling owners veto rights over key decisions, limiting the controller's prerogatives and potentially justifying a discount rather than a premium.

Owning a controlling interest in a business sounds like holding all the cards. In theory, you control the operational, financial, and investment decisions that shape the company's future. Market research confirms this advantage: controlling interests typically sell at a premium compared to noncontrolling stakes in the same business. But what happens when the company's governing documents tie your hands?

We recently encountered this scenario in our valuation practice, and it serves as a powerful reminder that not all controlling interests are created equal. Before applying a control premium, valuation analysts must dig into the bylaws, articles of incorporation, and operating agreements to understand what powers are actually granted to the controlling owner.

Why Control Matters

The concept is straightforward: controlling ownership interests are more valuable because they can exercise what we call the prerogatives of control. These include the ability to replace management, set employee compensation, declare distributions, buy or sell assets, take on debt, liquidate the business, amend governing documents, and run day-to-day operations.

Internal Revenue Service Ruling 59-60 supports this view, stating that control of a corporation, actual or in effect, representing as it does an added element of value, may justify a higher value for a specific block of stock. The logic is simple: if you can use these prerogatives to increase cash flow or reduce business risk, the market will pay more for your shares.

Conversely, noncontrolling owners face higher risk. They cannot exercise these prerogatives, and worse, a controlling owner might use their power in ways that harm noncontrolling interests. This risk justifies applying both a discount for lack of control and often a discount for lack of marketability to noncontrolling positions.

When Control Is Not What It Seems

Here is where things get interesting. Just because you own voting control does not mean you have operational control. The Articles of Incorporation or operating agreements might require supermajority approval for certain critical decisions, effectively giving noncontrolling owners veto power.

Consider a hypothetical example: you are valuing a 51 percent voting interest in XYZ Corporation. On paper, this looks like a controlling position. However, when you review the Articles of Incorporation, you discover that any shareholder distributions require approval from 75 percent of all stockholders. The nonvoting stockholders, who collectively own 49 percent, can block any distribution decision.

Now your controlling interest faces a liquidity problem. You might think the solution is simple: hire yourself as an employee and pay a higher salary to compensate for the lack of distributions, or amend the Articles to remove this supermajority requirement. But when you dig deeper, you find that setting compensation levels and amending the Articles also require 75 percent supermajority approval. You are stuck.

Quantifying the Impact

In situations like this, a valuation analyst faces a dilemma. The voting stock enjoys many common prerogatives of control and could theoretically increase cash flow or lower risk. However, the owner faces a high probability of receiving no current return on investment until the stock is sold to a third party, the company undertakes an initial public offering, or the business is liquidated. This additional risk demands compensation in the form of a valuation discount.

Research on the cost to obtain liquidity provides useful guidance. Studies such as The Seven Percent Solution and The Cost of Going Public have analyzed the costs companies incur preparing for and executing an IPO. Underwriter costs alone typically average 7 percent of deal size. When you add accounting and legal fees, the total costs range from 2.1 percent to 9.6 percent of IPO proceeds. For a privately held company with no immediate path to public markets, these costs could reach 5 percent to 10 percent of equity value.

In our XYZ example, a valuation analyst might select a 10 percent discount by weighing the empirical evidence from cost to obtain liquidity studies, the prerogatives of control that can be exercised unilaterally, the inability to obtain immediate liquidity, and the potentially long time horizon before receiving any investment return. This discount effectively considers both lack of unilateral control and lack of marketability.

The Critical Lesson for Valuation Analysts

This scenario underscores a fundamental principle: valuation is not a mechanical exercise. You cannot simply check a box that says controlling interest and automatically apply a standard premium. Every business is unique, with different organizational structures and governing provisions that affect what control actually means.

Revenue Ruling 59-60 reminds us that a sound valuation is based on all relevant facts. This includes a thorough review of bylaws, articles of incorporation, shareholder agreements, and any other documents that define the rights and limitations of different ownership classes. Without this review, you risk mistakenly assuming a subject interest has unilateral control when it does not.

Key Takeaways

•       Controlling interests typically command premiums because they allow owners to exercise prerogatives that increase cash flow or reduce risk, but this value depends on the actual powers granted.

•       Governing documents may require supermajority approval for key decisions, giving noncontrolling owners effective veto power and limiting what the controlling owner can do unilaterally.

•       When a controlling interest cannot obtain liquidity through distributions or other means, the cost to obtain liquidity studies provide empirical guidance for applying appropriate discounts.

•       Valuation analysts must thoroughly review organizational documents before applying control premiums to avoid mistakenly overvaluing interests with limited actual control.

Conclusion

Controlling ownership interests are generally more valuable than noncontrolling interests in the same business. The difference reflects the ability to influence decisions that affect cash flow and risk. However, this is only true when the controlling owner can actually exercise those powers. When organizational documents limit decision-making authority, what appears to be a controlling interest may function more like a noncontrolling one. In these situations, applying a discount rather than a premium may be the more accurate approach. The lesson is clear: always review the governing documents and understand what control really means before assigning value to any ownership interest.

Source: Willamette Management Associates, April 2025