Definition
Control Premium is the extra amount a buyer is willing to pay over the current market price of shares to obtain a controlling interest in a company. Control refers to owning a sufficient proportion of a company’s shares to dictate its strategic direction, influence or set policies, and manage operations, including major financial and operational decisions.
Key Points:
- Gaining Control: A controlling interest typically involves owning more than 50% of a company’s shares.
- Strategic Influence: Control premium reflects the strategic benefit and influence over business decisions.
- Value Recognition: Recognizing underlying value and potential synergies that a new management can achieve, which might not be reflected in the current stock prices.
Example
Three individuals each owned a one-third interest in a hotel. When one of the owners offered his interest for public sale, it was valued only at $100,000. However, each of the remaining owners was willing to pay $250,000 for that portion because it would grant them more than 50% ownership, thereby ensuring control over hotel operations. Here, the control premium was $150,000, representing the additional amount over the market price to gain control and influence over management policy and personnel decisions.
Frequently Asked Questions (FAQs)
1. What factors influence the size of a control premium?
Several elements can affect the magnitude of a control premium, such as the company’s overall strategic value, the fiscal health of the business, its governance structure, financial leverage, industry conditions, and existing managerial efficiency.
2. Is control premium applicable to minority shareholders?
No, control premium is specifically associated with acquiring a majority stake or enough influence over business decisions. Minority shareholders usually receive a minority discount instead of a premium.
3. Can control premiums vary across different industries?
Yes, control premiums can significantly differ between industries based on regulatory environments, the competitive landscape, growth potential, and the strategic synergies that an acquirer may realize in a given sector.
4. How are control premiums calculated?
Control premiums are often calculated by analyzing recent similar transactions within the same industry, comparing the offer price for a controlling stake to the market price of minority stakes, and determining the differences attributed to control benefits.
5. What is the significance of control in real estate investments?
In real estate investments, gaining control could mean making key operational decisions such as management policies, restructuring operations, setting rental rates, or even the disposition of assets. Thus, control premiums are critical in property acquisition deals where management decisions impact value.
Related Terms
Minority Discount
The reduction applied to the value of a minority shareholding, reflecting the minority shareholder’s lack of control over managerial decisions or strategic direction.
Fair Market Value
The estimated price at which an asset would trade between a willing buyer and seller, with neither under undue pressure to act, and both having reasonable knowledge of relevant facts.
Majority Stake
A situation where an entity holds more than 50% of a company’s shares, giving de facto control over decisions, policies, and governance.
Online Resources
- Investopedia Definition of Control Premium
- Harvard Law School Discussion on Control Premium
- Corporate Finance Institute - Control Premium
References
- Damodaran, Aswath. “Damodaran on Valuation: Security Analysis for Investment and Corporate Finance.” John Wiley & Sons, 2nd Edition.
- Pratt, Shannon P., Reilly, Robert F. “Valuing a Business: The Analysis and Appraisal of Closely Held Companies.” McGraw-Hill Education, 5th Edition.
Suggested Books for Further Studies
- “Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company Inc., Tim Koller, Marc Goedhart, and David Wessels.
- “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset” by Aswath Damodaran.
- “Equity Asset Valuation” by Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, and John D. Stowe.
