M&A Vocabulary – Understanding Experts: Discount for lack of control, control premium

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner present an important term from the specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give or refresh a basic understanding of a term and provide some useful tips from our consultancy practice.

A "control premium" is defined as an amount or percentage, by which the controlling interest, exceeds the non-controlling interest in an entity to reflect management power.

Conversely, an amount or percentage deducted from a proportionate share of 100 per cent of a company's shareholding, to reflect the lack of some or all control power is defined as a "discount for lack of control".

Large blocks of shares are often transferred at different prices than individual shares during day-to-day trading on the stock exchange. These relative price differences can be significant if the change in ownership of the shares leads to a change in control, such as when more than 50 per cent of the voting rights are acquired. In this case, a potential buyer may be willing to pay a higher price for the company shares than the price that would arise from a mathematical calculation if the equity value of the company as a whole was broken up into the number of shares involved in the transaction. The difference between the market price of a share quoted on the stock exchange and the price of the shares through which control is acquired can – at least in part – be attributed to such a control premium, paid for the acquisition of the power to manage the company’s operations.

For example, a company has two shareholders holding 80 per cent and 20 per cent of the shares, respectively. If the equity value of the company is 10 million euros, a reasonable buyer will usually not be willing to pay a price of 2 million euros for 20 per cent of the shares. The discount from the 2 million euros is – in part – the discount for lack of control.

Control Premium and Discount for Lack of Control in Acquisitions

For synergistic effects or rational reasons, add-on acquisitions or takeover bids may lead to premiums on the equity value or stand-alone value of the shares to be acquired. For the prospective buyer, it may be worth assessing before a transaction whether a premium actually constitutes a control premium or rather:

represents a premium for synergy effects;
covers aspects relating to tradability of shares;
ensures access to information relevant to the valuation; or
takes into account the quality of this information
or perhaps is simply an overpayment by the acquirer in order to induce as many shareholders as pos-sible to accept the bid.

The value at which the main shareholder can obtain its right of first refusal can be clarified in articles of association or shareholders' agreements of non-listed companies. A specific definition of the transaction price can limit or clarify the arbitrariness of the discount for lack of control.

Studies show that the level of the control premium depends on factors such as industry sector, time, type and size of the transaction, while the size of the company does not seem to be an influencing factor. In addition, it has been observed that the control premium in market-based systems where companies raise financing to a greater extent via the capital market, is significantly higher than in bank-based systems.

The level of the control premium may vary depending on which and how many aspects of control are included in the premium, as well as the level of worth, that the acquirer, via his opportunities to influence, can convert to the business as appreciation in value.

Conclusion

In the case of transactions involving blocks of shares, which result in a transfer of corporate control, the encirclement of the control premium in terms of value, can make up a considerable proportion of the transaction price.

The economic understanding of the distinction between the control premium and possible other premiums or discounts enhances the quality of the bid in connection with the calculation of the value-added that the share acquisition can create for the acquirer.

Similarly, the discount for lack of control is an important aspect for minority shareholders in terms of understanding how the value of shares is derived in light of definitions included in articles of associations or shareholders' agreements. Minority shareholders of a company should clearly define the valuation method in articles of associations or a shareholders' agreement in order to understand the minority discount concept that can be applied when disposing of their shares. This is because the definition of contractual provisions on the disposal of shares can significantly influence the process of determining the value.