Part 3: Understanding price implications of deal structure
This is Part 3 of a multipart blog series on negotiating the price of a small private company. If you missed the previous post, click here.
As the expression goes, “there are many ways to skin a cat”. Nothing could be truer in deal structuring: there are innumerable ways to achieve desired outcomes, share risks and create the right incentives. That said, it’s impossible to “structure around” the most critical issue in any deal: control.
When it comes to valuing and structuring a deal to sell a small business, the perceived degree of control can justifiably swing views on price. Is the buyer buying 100% of the target company? 51%? Or a smaller minority position less than 50%? Regardless, will the transaction result in a change of control?
Typically, it can be argued that a full buyout of a small business, or an acquisition that enables clear control for the buyer, attracts what’s called a “control premium” because it affords the buyer more agency in the post-transaction outcome.
On the flip side, if a small business buyer is acquiring a smaller percentage of the shareholding (typically less than 50%), the price sometimes warrants a “minority discount”, because the buyer, in taking a non-controlling interest, will have so little influence over the eventual outcome (basically the inverse of the control premium noted above).
Importantly, this minority discount should not be confounded with what is often called an “illiquidity discount” or “lack of marketability discount”, which speaks to the difficulty of exiting the investment. An illiquidity discount applies regardless of control, because it relates to the nature of the asset, not the control over it. As such, when valuing a small private company, it should already be included in the original valuation analysis (as it is in the EquityMaven techniques).
When it comes to small business valuation methods, control premia and minority discounts can be much more nuanced – and they aren’t always just a function of buying/selling the majority (or minority) of shares in the targeted company. There can be other classes of shares that still hold special voting rights, or other deal terms that afford certain parties to keep control, regardless.
The key issue when valuing a small business to sell it is to focus on practically, is which party will have the final say in strategic decision-making, post transaction. And this dynamic should inform your negotiating position on price, because clear control typically warrants a higher price, whereas no control often attracts a lower price.
To learn more about small business valuation methods, keep reading Part 4 in our Negotiating the Sale of a Small Private Company series, where we look at the characteristics of business model design that can enhance value. A reminder, a complete version of this content is available to EquityMaven’s subscribers in e-book format.