Considerations involved in estimating the fair value of a noncontrolling interest

As discussed in Section 8.1.2, the FASB issued ASU 2011-04 in May 2011. This ASU amends the guidance in Topic 820 on the subject of including premiums and discounts in a fair value measurement. Guidance on how premiums and discounts should be taken into consideration in estimating the fair value of a noncontrolling interest is discussed in this section. Refer to Section 8.1.2 for the effective date and transition guidance applicable to ASU 2011-04.

Any noncontrolling interest in the target at the acquisition date should be measured and recorded at its acquisition-date fair value. If there is an active market price for the shares not held by the buyer (i.e., the shares held by the noncontrolling interest), then that active market price multiplied by the number of shares held by the noncontrolling interest represents the fair value of the noncontrolling interest. This is supported by the guidance in FASB ASC 820-10-35-41, which states the following:

ASU 2011-04 clarified that, if available, a quoted price in an active market should be used “without adjustment”

when measuring fair value. This is consistent with the practice that had developed with respect to measuring the fair value of the noncontrolling interest prior to the issuance of ASU 2011-04.

In some situations it may not be clear whether the market that produces a quoted price is an “active” market.

FASB ASC 820-10-35-51A through 51D (before ASU 2011-04) and FASB ASC 820-10-35-54C through 54H (after ASU 2011-04) provide guidance on this subject.

After ASU 2011-04

A quoted price in an active market provides the most reliable evidence of fair value and shall be used without adjustment to measure fair value whenever available, except as specified in paragraph 820-10-35-41C.*

Before ASU 2011-04

A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available, except as discussed in paragraphs 820-10-35-16D, 820-10-35-42, and 820-10-35-43.*

*The Codification references listed in the quote do not address measurement issues specific to a noncontrolling interest.

When there is not an active market price for the shares held by the noncontrolling interest, then the fair value of the noncontrolling interest could be estimated directly by using one or more valuation techniques (e.g., market and (or) income approaches). Alternatively, it may be appropriate to determine the fair value of the noncontrolling interest indirectly by taking the fair value of the target as a whole and subtracting the consideration transferred by the buyer for the controlling interest.

When there is not an active market price for the shares held by the noncontrolling interest and the fair value of the noncontrolling interest is estimated using another valuation technique, a question often arises as to whether the consideration transferred by the buyer for a controlling interest can be used to extrapolate the fair value of the noncontrolling interest. Generally, the answer to that question is “No” because the buyer would often be willing to pay more on a per-unit basis for a controlling ownership interest (more than 50%) in an entity than a noncontrolling ownership interest (50% or less) in that entity. The incremental amount that a buyer would be willing to pay on a per-unit basis to obtain a controlling interest in an entity (compared to a noncontrolling interest in an entity) is referred to as a control premium. Conversely, the discount an investor would require to obtain a noncontrolling interest in the same entity is referred to as a noncontrolling interest discount.

The existence of a control premium or a noncontrolling interest discount would make it inappropriate for the buyer to determine the fair value of the noncontrolling interest solely by extrapolating what it paid for the controlling interest. Consider a situation in which the buyer pays $8,000,000 for an 80% interest in the target.

It would not be appropriate in this situation to assume that the fair value of the 20% noncontrolling interest is $2,000,000 (or that each individual percent ownership in the target is worth $100,000). The $8,000,000 paid for the 80% interest in the target generally reflects a control premium. The control premium included in the

$8,000,000 paid for the 80% interest in the target should generally not be reflected in the valuation of the 20%

noncontrolling interest.

The fact that the per-share values of the controlling and noncontrolling interests would differ due to a control premium or a noncontrolling interest discount is supported by FASB ASC 805-20-30-8, which indicates the following:

The language added to FASB ASC 805-20-30-8 by ASU 2011-04 makes it clear that including a noncontrolling interest discount in the per-share fair value of the noncontrolling interest is appropriate only if market participants would include such a discount when pricing the noncontrolling interest. When there is an active market price for the shares held by the noncontrolling interest, any noncontrolling interest discount is effectively presumed to be reflected in the active market price. As such, a separate adjustment to the active market price to reflect a noncontrolling interest discount is not necessary or appropriate. When there is not an active market price for the shares held by the noncontrolling interest and the fair value of the noncontrolling interest is

After ASU 2011-04

The fair values of the acquirer’s interest in the acquiree and the noncontrolling interest on a per-share basis might differ. The main difference is likely to be the inclusion of a control premium in the per-share fair value of the acquirer’s interest in the acquiree or, conversely, the inclusion of a discount for lack of control (also referred to as a noncontrolling interest discount) in the per-share fair value of the noncontrolling interest if market participants would take into account such a premium or discount when pricing the noncontrolling interest.

Before ASU 2011-04 The fair values of the acquirer’s interest in the acquiree and the noncontrolling interest on a per-share basis might differ. The main difference is likely to be the inclusion of a control premium in the per-share fair value of the acquirer’s interest in the acquiree or, conversely, the inclusion of a discount for lack of control (also referred to as a minority interest discount) in the per-share fair value of the noncontrolling interest.

estimated using another valuation technique, whether and how a noncontrolling interest discount is reflected in the valuation technique depends on whether and how a market participant would reflect a noncontrolling interest discount in the valuation technique.

The payment of a control premium by the buyer is certainly expected to benefit the buyer as the buyer is obtaining control over the target’s business. However, in limited situations, the noncontrolling interest may also benefit from the buyer’s payment of a control premium. In other words, some of the incremental value received by the buyer as a result of the control premium may also benefit the noncontrolling interest. In a sense, any incremental benefit received by the noncontrolling interest would result in a lower noncontrolling interest discount. Consider a situation in which the payment of a control premium allows the buyer to benefit from economies of scale it can achieve by coordinating some of its existing operations with the target’s operations.

It is possible in this situation that the noncontrolling interest may also benefit from these economies of scale.

But, how do the benefits to the noncontrolling interest get reflected in the valuation of the noncontrolling interest? When there is an active market price for the shares held by the noncontrolling interest, then it would be reasonable to expect that any benefit expected to be received by the noncontrolling interest from these economies of scale would be reflected in that active market price. When the fair value of the noncontrolling interest is estimated using another valuation technique (because there is not an active market price), the buyer should consider whether the valuation technique used appropriately reflects any of the benefits the noncontrolling interest would expect to receive from these economies of scale. In many cases, the valuation technique used would take those expected benefits into consideration and it would not be necessary to make an explicit adjustment to the output of the valuation technique for those expected benefits.

Given the complexities that may arise in determining the fair value of a noncontrolling interest, particularly when there is not an active market price for the shares held by the noncontrolling interest, it is often prudent to consult a valuation specialist when faced with the task of measuring the fair value of a noncontrolling interest.

In 2011, the AICPA issued a working draft of a practice aid entitled, “Valuation of Privately Held Company Equity Securities Issued as Compensation.” While the scope of the working draft does not explicitly address estimating the fair value of a noncontrolling interest in a private entity, many of the general concepts discussed in the working draft are relevant in that situation. Additional information about the working draft and expected new edition of the practice aid (including their lack of authoritative standing) is provided in Section 12.3.3. Refer to the AICPA’s website (www.aicpa.org) for information related to the working draft and the status of the expected new edition of the practice aid.

Example 10-7: Fair value of noncontrolling interest

Buyer acquires a 60% interest (120,000 shares) in Target for $7,200,000. As such, Buyer is paying $60 per share for its ownership interest in Target. The only ownership interests in Target consist of common stock that is traded on the NYSE. Buyer did not own any interest in Target prior to acquiring its 60% interest. As a result of acquiring the 60% interest, Buyer controls Target, which results in Buyer accounting for the acquisition of the 60% interest in Target as a business combination. The noncontrolling interest in Target (40% of the common stock of Target) is equivalent to 80,000 shares. The price of Target’s stock on the NYSE on the acquisition date is $55 per share.

The difference between the per-share price of Target’s stock on the NYSE on the acquisition date ($55) and the per-share price paid by Buyer ($60) is a control premium. The fair value of the noncontrolling interest would be

$4,400,000 (80,000 shares * $55 per share) in this situation.