How would you value (at fair market) control vs. minority interests in a business whose liquidation value far exceeds going concern value?
I think we all agree that the control interest should be valued at liquidation, consistent with highest and best use and exercise of the control prerogative to liquidate. Even if the control owner plans not to liquidate, that is an irrational decision, and fair market value implies rational parties. (The decision not to liquidate is an investment value decision based on the control owner’s personal situation. Maybe they think the company can grow profitably. Maybe they want to pass the business to the next generation. Whatever.)
The minority interest is another story. This owner cannot force liquidation short of filing an oppression suit – risky and costly. I would not disagree with those who value the minority interest at going concern value. In fact, that is how I did it for many years. I was never challenged or rebutted.
Now I am rethinking things. The minority owner of a business with high liquidation value and low going concern value may not be able to force liquidation, but if it happens, they effectively own a lottery ticket on the (higher) liquidation value. That value is not reflected in going concern value.
I can think of two general ways to capture the lottery ticket value:
1. Value the stock as an option on liquidation value. The minority stock is a deep in-the-money call option on liquidation value. Using Black Scholes comports with financial theory, but I have problems specifying the assumptions. Black-Scholes assumes that an option will be exercised if the asset price exceeds the strike price. But we already know that the majority owner controls the ability of the minority owner to exercise the option. So Black-Scholes will not work. Perhaps a binomial lattice model would work, but there would have to be some decision rule built in that would determine when the company would liquidate and at what price. Quite simply, this is beyond me.
2. Do a DCF analysis with (projected) liquidation value as the terminal value. I can se4e exactly how to do this. There would have to be sensitivity analysis about how long until liquidation and liquidation value, but this is very doable. Now, compare this to a baseline DCF with no liquidation (going concern value). Now, make a major assumption about the probability of liquidating or not. The weighting will give some probabilistic value to going concern and some to liquidation.