August 2022
According to the International Valuation Glossary - Business Valuation, 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 business, to reflect the anticipated economic benefits of Control. Also known as acquisition premium.”
The financial media often mention the premium that a buyer pays over the market price to acquire a public company in a percentage term such as “a 25% premium.” This control premium reflects the dollar amount per share paid by the acquirer over the price per share prior to the announcement of the acquisition. This is calculated as acquisition price divided by the prior price minus 1. For instance, if the acquisition price was $12.50 per share and the prior price was $10.00 per share the control premium is calculated as (($12.50/$10.00) – 1) = $0.25, or 25%. The control premium is normally based on the equity (stock) values per share, or the value of the company net of debt. However, unusually low or high debt levels can distort the control premium to such a degree that it’s meaningless. The anticipated economic benefits that acquirers pay for a business via a control premium does not usually change based upon the debt levels of the acquired business. For example, an acquirer determines that the benefit of controlling the target business is worth $100 million due to the ability of the acquiring business to cross-sell its products in additional markets. The value of these economic benefits doesn’t change with the level of debt of the target. But, since equity prices are calculated net of debt, very high or very low debt levels will distort the control premium paid. Using the prior example, assume that the target company had additional debt of $5.00 per share. The prior value would then become $5.00 per share ($10.00 - $5.00) and the acquisition price would be $7.50 ($12.50 - $5.00). The control premium would then be (($7.50/$5.00) – 1) = $0.50, or 50%.
Since debt can distort control premiums that are based on equity values, some sources report control premiums as a percentage of enterprise value (equity value plus debt) as well as on equity values. Mergerstat Review reports that the median control premium based on equity values in 2021 was 29.8%. This is compared to the 2021 median control premium based on enterprise value of 30.8%. Since these values are very close it appears that maybe debt doesn’t distort the median very much, but medians aren’t affected by outliers.
When valuing a business that has very high or low debt levels relative to the target companies that the control premium will be derived from, it is best to utilize control premiums based on the debt-neutral enterprise value.
Relevant Court Cases
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Simons v. Simons,
Nebraska Supreme Court, 312 Neb. 136,
filed August 5, 2022
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In Re GGP, Inc. Stockholder Litigation,
Supreme Court of Delaware No. 202, 2021,
filed July 19, 2022
Recent Business Valuation Articles
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“Simulation-based Business Valuation,”
by Dr. Dietmar Ernst and Dr. Werner Gleibner,
posted August 9, 2022
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“Measuring Uncertainty in Illiquid Markets,”
by Dragana Cvijanovic, Stanimira Milcheva and Alex Van De Minne,
dated July 22, 2022
Recent Engagements
- Valuation of the common stock of a civil engineering
contracting company on a minority interest
basis for employee stock ownership plan purposes.
- Valuation of the non-voting common stock of
a home healthcare firm on a minority interest
basis for gift tax reporting purposes.
- Valuation of a member interest of a real
estate holding company on a minority interest
basis for estate tax reporting purposes.
- Valuation of non-voting class B membership
units in an investment holding company on a
minority interest basis for gift tax reporting purposes.
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