Valuation Adjustments The most common types of valuation adjustments are discounts for lack of control, which address the degree of control, if any, attributable to a particular interest and discounts for lack of marketability, which address the ability to liquidate an investment in a timely and certain manner.    Most business valuators agree that the three primary levels of value: Control, Marketable Minority and Non-marketable Minority, are related to each other by the valuation adjustments made: Control Premium, Minority Interest Discount, and Marketability Discounts.    There are no prescribed levels of valuation adjustments, the facts and circumstances of each case  determine the adjustments, if any, to be made on the basis of the level of value obtained from applying the selected valuation methodology.       Control Discounts and Premiums: A Primer   The application of discounts and premiums in valuing interests in privately held companies is often misunderstood by users of valuation reports. This article focuses on discounts and premiums based on a shareholder's degree of control over the entity being valued. We'll address other potential adjustments, such as the discount for lack of marketability, in future publications.   The key to understanding discounts and premiums is to recognize that they represent adjustments to some base definition of value. Until the base value is clearly defined, it's impossible to determine what sort of adjustment, if any, is appropriate for the interest in question.   A particular valuation method, for example, may produce a control level of value. If that method is used to value a minority interest in a privately held company, a discount for lack of control may be appropriate. Conversely, if a valuation method produces a minority value and a controlling interest is being valued, a premium might be considered.   An examination of the four most common valuation methods and their resulting levels of value will help illustrate this concept.   Asset-Based Approach - Cost Method   Under this method, the valuator examines the company's balance sheet and marks assets and liabilities, both tangible and intangible, up or down to fair market value. The difference is the value of equity.   This method generally produces a control level of value because only a control owner has the power to sell or liquidate the company's assets. If a controlling interest is being valued, a control premium wouldn't be warranted, because control is already reflected in this method.   If, however, the purpose of the valuation is to estimate the value of a minority interest, the indicated value should be adjusted for lack of control.   Income Approach - Discounted Cash Flow Method   Under this method, the valuator computes the present value of the company's estimated future cash flow. Arguably, this method can produce either a control or a minority level of value depending on whether control is reflected in the cash flow projections. If estimated future cash flow includes elements of control, for example, then the DCF method would yield a control level of value.   "Elements of control" refers to the ability of a controlling shareholder to enhance the value of his or her shares by directing or influencing business policies. A common example is owner compensation. It's not unusual for an owner who works in the business to receive above-market compensation. The buyer of a controlling interest would be in a position to ensure that executive salaries reflect the value of services provided, thereby boosting the company's income and increasing shareholder value. If projected cash flow is based on "normalized" compensation levels, then it's arguable that the result is a control level of value, since only a controlling shareholder would have the power to set compensation levels.   If a minority interest is being valued and projected cash flow reflects elements of control, then a discount for lack of control might be warranted. If a control cash flow isn't used, then the result would already reflect a minority level of value and a further discount wouldn't be appropriate.   Market Approach - Guideline Public Company Method   Under this method, the valuator determines the value of the subject company based on the market price of publicly traded stock of similar public companies. Typically, the valuator computes a "multiple" by dividing the price of the guideline company's stock by an economic variable - usually some measure of earnings - and then applies an adjusted multiple to the same variable in the subject company. Because the prices of publicly traded stock are based on minority interest transactions, this method produces a minority level of value.   If a minority interest is being valued, then the result would already reflect a minority level of value and a discount for lack of control wouldn't be appropriate. If a control interest is being valued, a control premium might be considered.   Market Approach - Merger and Acquisition Method   Here, the valuator applies adjusted multiples derived from the prices at which entire companies or operating units, or substantial interests in companies, have changed hands. Because M&A transactions almost always involve controlling interests, this method yields a control level of value.   If a minority interest is being valued, a discount for lack of control might be considered. If a control interest is being valued, the result would already be a control level of value, and no premium for control would be appropriate.   Major issues surround minority interest discounts    Among the most common ? and sizable ? valuation discounts is the discount for lack of control (also called the minority interest discount).   Minority interests generally trade at a discount from their pro rata share of a company's overall enterprise value, because minority shareholders can't control key aspects of the company's operations. They can't, for example, hire management, set policy, liquidate the company or its assets, register for a public offering, or declare dividends. This article discusses major issues that surround minority interest discounts.