Acquisitions of Minority Interest

Once the transfer is effective, the minority interest owner has no control of any management decisions, equipment acquisitions, or personnel decisions unless an agreement has been reached in advance of the acquisition to overcome the lack of control now owned by the minority shareholder. It is vital to the minority interest owner that there is a clear definition of any buyout arrangement in the operating agreement so that upon the sale of the shares, there is no question about the worth to the seller in the event that a third-party buyer is not found. This occurs in many buy-sell agreements when the corporation is the buyer at a set price or agreed-upon formula for determining the price before the seller of the minority interest has an opportunity to offer his or her shares for sale to an outsider.

As a buyer or a seller, another important consideration is the ability to find a buyer for the shares owned by someone with a less-than-majority interest in the laboratory. Besides the lack of control accompanying the stakeholder, the ability to find someone to acquire those shares lessens as potential buyers realize that they will have almost no rights in the management of the laboratory. If those laboratory owners who have been through a transition recall the points of concern when transferring all of their shares, they will now have a new set of circumstances trying to find the purchaser of less than a controlling interest in the laboratory. The number of those interested reduces in an almost geometric proportion as the percentage of the ownership for sale decreases.

Let's look at an example for support of the loss in value of a minority ownership interest in a laboratory. Calculating a minority interest in a laboratory using a 20% stake as an example, let's suppose that there is an acceptable laboratory valuation and all of the parties involved with the potential sale and acquisition have agreed that the entire laboratory has a certain value. That amount includes all of the tangible and intangible assets. Let's also assume that the hypothetical worth of the laboratory in the valuation was $1,000,000. Remember that a minority ownership interest in a closely held business lacks sufficient voting power to independently control the operations of the business. Because of this, shares are less valuable to investors than shares of a controlling interest. This is compared to a minority interest in a publicly traded company where a stock broker can be called and the stock can be sold immediately for an easily determined price from the many trades that are occurring. Typically, the average discount for the lack of control for shares of a minority ownership interest is about one third of the value of the controlling shares. Starting at a $200,000 computation for the 20% share of the $1,000,000 value, we then use the one-third reduction, or $66,667, as a subtraction from it. We are then left with a value to the 20% shareholder of $133,333 because of the lack of control that a potential buyer will have after the purchase of the minority owner's share.

Another discounted amount for the shareholder with a minority ownership interest is the lack of marketability. An ownership interest is worth more if it can be easily sold than if it cannot be easily sold. Privately owned laboratories are not traded in the public market place so they are more difficult to sell than shares in a publicly held corporation. Factors contributing to this difficulty include the smaller pool of potential buyers for shares in closely held corporations and the greater time and expense associated with selling such shares. If this relative lack of marketability is factored into determining the value of shares of a minority interest in a closely held laboratory, they can be reduced by an additional 35% to 50%. Now, we are looking at the $1,000,000 worth of the laboratory as a whole being reduced to $133,333 because of the lack of control as previously described. From that $133,333, we would then subtract on the low side, an additional 35% of that amount: $46,667. The value of the 20% interest then equates to $86,666. If you are a laboratory owner of a 20% minority interest and you have no prearranged buyout price or formula or fixed price per share in your operating agreement, be prepared for an astute buyer of your interest to offer in the range of $86,666 for your 20% share. The low value is based on the lack of control in the minority ownership interest and the lack of marketability in that discounted arrangement. Of course, negotiations are always possible, but do not be surprised if the price is in that range.

As much as those laboratory owners and operators may not want to spend money on legal fees, one of the most important safe guards for the minority percentage owner of shares is to finalize the operating agreement so that those previously described discounts do not apply. The time and money spent on good legal representation will more than pay for itself when offering the sale of the ownership rights in those shares. The sooner this step is accomplished, the faster the minority interest owner will be protected in the ability to receive more of a percentage of the total valuation without any discounting based on the language in the agreement.

Bruce Bryen, CPA, CVA, is the principal in the firm of Baratz CPA and Associates in Fort Washington, Pennsylvania.