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Logic dictates that valuation experts assume that cash is worth its face value in majority interest or control scenarios. And that assumption makes sense: In such instances, control of a company provides access to and control over the assets, including cash.
But experts fail to see that in minority interest valuations for both private and public companies, a different perspective is required - particularly when excess cash is held within a private operating business.
There are many reasons why excess cash in minority interest valuations should be evaluated carefully and valued separately from a company's operations. Imagine, for example, that a company has entrenched management and poor investment opportunities; clearly, in such a case, we should significantly discount excess cash. Even if a company is doing well, it often makes sense to discount excess cash in minority interests.
On the other hand, cash may be valued at a premium to face value if management is responsive to investor requirements, management's interests are aligned with investors, and a company has unique investment opportunities.
Valuation experts who fail to distinguish between cash in majority interest or control situations versus minority situations risk overvaluing a company. Of course, that, in turn, can lead to a client overpaying gift and estate taxes. This failure to distinguish between cash in majority interest situations versus minority interest situations is even more important these days as many companies are holding more cash reserves hoping to weather the uncertainties of the current economic environment. (Google, for example, has about 60 percent of its total book assets in cash.)
Excess cash can be worth significantly less than its face value to minority investors - as much as a 65 percent to 70 percent less.
Here's why.
The Basics
The first step in most primary going-concern valuation methods (such as the discounted cash flow analysis, public comparable method, and transaction approach) is to determine a company's "enterprise value." Enterprise value is derived by adding the value of the debt and equity together, then subtracting the total cash and equivalents balance. To determine the equity value, a valuation analyst subtracts the fair value of the debt from the enterprise value and adds the total cash and equivalents balance.
For example, assume the enterprise value of...