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A control premium is an amount that a buyer is sometimes willing to pay over the current market price of a publicly traded company in order to acquire a controlling share in that company. If the market perceives that a public company's profit and cash flow is not being maximized, capital structure is not optimal, or other factors that can be changed are impacting the company's share price, an acquirer may be willing to offer a premium over the price currently established by other market participants. A discount for lack of control, sometimes referred to as a
minority discountMinority discount is an economic concept reflecting the notion that a partial ownership interest may be worth less than its proportional share of the total business. The concept applies to equities with voting power because the size of voting positio ...
, reflects the reduction in value from a firm's perceived optimal or intrinsic value when cash flow or other factors prevent optimal value from being reached.


Overview of concept

Transactions involving small blocks of shares in public companies occur regularly and serve to establish the market price per share of company stock. Acquiring a controlling number of shares sometimes requires offering a premium over the current market price per share in order to induce existing shareholders to sell. It is made through a tender offer with specific terms, including the price. Higher control premiums are often associated with classified boards. The amount of control is the acquirer's decision and is based on its belief that the target company's share price is not optimized. An acquirer would not be making a prudent investment decision if a tender offer made is higher than the future benefit of the acquisition.


Control premium vs. minority discount

The control premium and the minority discount could be considered to be the same dollar amount. Stated as a percentage, this dollar amount would be higher as a percentage of the lower minority marketable value or, conversely, lower as a percentage of the higher control value. \mbox = \mbox \left(\right) Source:


Size of premium

In general, the maximum value that an acquirer firm would be willing to pay should equal the sum of the target firm's intrinsic value,
synergies Synergy is an interaction or cooperation giving rise to a whole that is greater than the simple sum of its parts. The term ''synergy'' comes from the Attic Greek Attic Greek is the Greek language, Greek dialect of the regions of ancient Greec ...
that the acquiring firm can expect to achieve between the two firms, and the opportunity cost of not acquiring the target firm (i.e. loss to the acquirer if a rival firm acquires the target firm instead). A premium paid, if any, will be specific to the acquirer and the target; actual premiums paid have varied widely. In business practice, control premiums may vary from 20% to 40%. Larger control premiums indicate a low minority
shareholders' protection Shareholders' protection is a contingency process detailing what will happen to a shareholder, shareholder's shares if the shareholder dies or becomes seriously ill. In the interests of Economic security, financial security, business stability, and ...
.


Example

Company XYZ has an
EBITDA A company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, with a specific objective. Company members sha ...
of $1,500,000 and its shares are currently trading at an EV/EBITDA multiple of 5x. This results in a valuation of XYZ of $7,500,000 (=$1,500,000 * 5) on an EV basis. A potential buyer may believe that EBITDA can be improved to $2,000,000 by eliminating the CEO, who would become redundant after the transaction. Thus, the buyer could potentially value the target at $10,000,000 since the value expected to be achieved by replacing the CEO is the accretive $500,000 (=$2,000,000–$1,500,000) in EBITDA, which in turn translates to $2,500,000 (=$500,000 * 5 or =$10,000,000–$7,500,000) premium over the pre-transaction value of the target.


See also

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Business valuation Business valuation is a process and a set of procedures used to estimate the economic value In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), product ...

Business valuation
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Divestment In finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...
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Equity value Equity value is the value of a company available to owners or shareholders. It is the enterprise value plus all cash and cash equivalents, short and long-term investments, and less all money market, short-term debt, long-term debt and minority inter ...
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Enterprise value Enterprise value (EV), total enterprise value (TEV), or firm value (FV) is an economic measure reflecting the market value Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a Market (economics), competitive ...
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Goodwill (accounting) In accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been calle ...
* M&A *
Takeover In business, a takeover is the purchase of one company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, w ...


References


External links


Control Premiums, Minority Discounts & Marketability Discounts
{{DEFAULTSORT:Control Premium Corporate finance Equity securities Stock market Mergers and acquisitions