Control Premiums: How Much is Control Worth?
The majority of corporate acquisitions are acquisitions of majority interests. In their latest M&A column, Les Nemethy and Sergey Glekov look at the issue of control in such circumstances.
With a mere 50% ownership plus one share, an acquiror can often exercise substantial or nearly total control over an acquired company. In widely held companies, sometimes control can be had with significantly less than 50% ownership. Each share that has this bundle of control rights attached to it is worth more than a share that does not. This gives rise to what is known as a “control premium”.
Corporate control has been defined in “The Market For Corporate Control: The Scientific Evidence” by Michael C. Jensen and Richard S. Ruback as: “the rights to determine the management of corporate resources”. The following is a list of the more common prerogatives of ownership control of a business enterprise, as laid out in “Value a Business » by Shannon Pratt, Robert Reilly and Robert Schweihs:
• Appoint management
• Determine management compensation and perquisites
• Set policy and change the course of business
• Acquire or liquidate assets
• Select people with whom to do business and award contracts
• Make acquisitions
• Liquidate, dissolve, sell out, or recapitalize the company
• Declare and pay dividends
• Change the articles of incorporation or bylaws
• Block any of the above actions
The above rights are typically available to a controlling or interest only, or must be taken by a majority of shareholders. Therefore, part of the purchase price paid by an acquiror most likely includes a payment for obtaining control, the control premium, defined as “an amount or a percentage by which the pro rata value of a controlling interest exceeds the pro rata value of a non-controlling interest in a business enterprise to reflect the power of control” (“Business Valuation Discounts and Premiums” by Shannon Pratt).
According to Mergerstat’s Control Premium Study from Q2 2018, there are a number of factors affecting the magnitude of a given control premium, including:
• The nature and magnitude of non-operating assets
• The nature and magnitude of discretionary expenses
• The perceived quality of existing management
• The market evolution
• The nature and magnitude of business opportunities which are not currently being exploited
• The ability to integrate the acquiree into the acquiror’s business or distribution channels
As a result of the aforementioned factors, control premiums can vary greatly. The chart blow provides statistics for Q2 2018 based on completed transactions, where the target company was publicly traded, and where at least 50.01% of a company was acquired.
Average control premiums in Europe in the second Quarter of 2018 are lower than in the United States and globally.
It should be noted that, when a control premium is payed, it is very difficult to strip out the synergies between the acquiror and acquired company on the one hand and the control premium on the other hand. The above exhibit includes both.
Once control is obtained, increasing ownership further does not lead to additional benefits of control. For instance, if 50.01% already guarantees control, there are no reasons for an acquiror to pay a control premium for purchase of subsequent shares, in excess of 50.01%.
In some countries, there are statutory minority protection rights, triggered when a minority shareholder owns a significant minority of shares (usually a minimum of one quarter to one third of shares). But these minority rights do not typically offer the right to manage the company. These rights are typically defensive in nature (e.g. protecting against dilution, exercising rights in bankruptcy, etc.)
Of course, it is always important to check applicable corporate laws and whether a company has a shareholders’ agreement – and if so, the details of such agreement – because such laws and shareholders’ agreement may confer special rights on a minority shareholder, such as rights of first refusal. To the extent that minority shareholders exercise significant powers (e.g. to veto certain decisions), these may diminish the control premium.
In conclusion, the control premium is proportional to the bundle of rights exercised by the controlling shareholder vis-à-vis the minority shareholder(s), and to the additional value that may be captured by exercising such control.
Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.
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