Do voting rights matter when valuing closely held business interests?

Differences in owners’ voting rights can impact the value of a business interest — but not always. A business valuation professional must thoughtfully evaluate ownership rights and restrictions to arrive at a reliable value conclusion. Here’s how the pros factor voting rights (or lack thereof) into the valuation equation.

A matter of control

The issue of voting rights relates to control. Owners of controlling business interests usually enjoy certain rights over other owners. These rights may be contractually or statutorily prescribed. For instance, in some states, a simple majority is sufficient for most critical decisions, such as mergers, sales, liquidations and acquisitions. Other states may require a two-thirds or greater majority to approve such actions. These variations can significantly affect the rights of noncontrolling owners and, in turn, the value of their interests.

In addition, when drafting business agreements, attorneys may use voting and nonvoting stock classes, or similar structures (such as general partner and limited partner interests), to segregate a company’s voting rights. These provisions can further limit the influence of owners without voting rights, potentially making their shares less attractive to hypothetical buyers. Conversely, owners with voting rights may be able to influence key business decisions, potentially increasing the value of their shares.

Key question

Voting rights don’t always translate into actual control over business decisions. For example, in a private corporation with a single dominant shareholder, someone who owns 3% of the company’s stock may have little practical influence even if the stock includes voting rights. When comparing voting vs. nonvoting stock, a valuator must first and foremost determine whether the owner of the voting shares can, in fact, derive additional economic benefits from those rights.

If the answer is yes, then voting shares are generally worth more than nonvoting ones. This situation is more common in controlling ownership positions. But each situation is unique, so valuators assess all relevant facts.

If the answer is no, then the matter isn’t as clear. In many cases, voting rights alone may not justify a significant difference in value. The best way to calculate any value differential between voting and nonvoting interests remains a matter of professional judgment, with each case presenting its own facts.

A custom approach

The issue of voting vs. nonvoting share value typically comes into play in shareholder disputes, mergers and acquisitions, and estate planning contexts. Historically, the IRS has suggested that a company’s voting shares may be worth more than its nonvoting shares. However, any premium applied to voting shares (or, conversely, any discount applied to nonvoting shares) can’t be based on speculation or hypothetical scenarios involving specific individuals. Any value differential is typically modest and appropriate only when supported by case facts.

Key factors that valuators consider when quantifying the value differential include:

Ownership structure. If one shareholder controls the company, voting rights may have limited value.

Owners’ agreements and state law. Transfer restrictions, veto rights or supermajority requirements can amplify or diminish voting power.

Distribution rights. If nonvoting shares have identical economic rights to dividends (or distributions) and in liquidation, the discount may be limited.

Voting rights tend to matter more when they can actually be used. For instance, in a potential sale or recapitalization, voting shareholders may have influence over the outcome or timing of the transaction. If no such opportunity exists, voting rights may have minimal incremental value.

Get it right

The value of voting rights isn’t a clear-cut issue. Most valuation professionals agree that, in theory, voting shares may have some incremental value above nonvoting shares. But the magnitude of that difference depends on the facts and circumstances. Careful consideration of ownership rights is essential when structuring transactions, drafting business agreements and planning for the future. Contact us to learn more.

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