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.[1]

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 discount, 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

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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.[2] Higher control premiums are often associated with classified boards.[3]: 165 

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

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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.

 

Source:[4]

Size of premium

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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 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%.[5] Larger control premiums indicate a low minority shareholders' protection.

Example

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Company XYZ has an EBITDA 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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References

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  1. ^ Damodaran, Aswath. "The Value of Control: Some General Propositions" (PDF). NYU Stern. Retrieved 4 March 2019.
  2. ^ Damodaran, Aswath (2005). "The Value of Control: Implications for Control Premia, Minority Discounts and Voting Share Differentials". NYU Journal of Law & Business. doi:10.2139/ssrn.837405. S2CID 16798738.
  3. ^ Bebchuk, Lucian A.; Hirst, Scott; Rhee, June (2014-02-01). "Towards the Declassification of S&P 500 Boards". Harvard Business Law Review. Rochester, NY. doi:10.2139/ssrn.2400652. S2CID 168499979. SSRN 2400652.
  4. ^ Pratt, Shannon P. (2009). Pratt, Shannon P (ed.). Business Valuation Discounts and Premiums (2nd ed.). Hoboken, N.J.: Wiley. p. 17. doi:10.1002/9781119197539. ISBN 978-0-470-37148-0. Retrieved 12 August 2020.
  5. ^ "CONTROL PREMIUM STUDY 2017: Insights into market dynamics, financial dynamics and other factors" (PDF). RSM International Association. Retrieved 4 March 2019.
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