ClarityBV Blog

The Problem: What is the value of a 75% ownership interest in a company whose only asset is cash? Would it make a difference if I told you it was a nonvoting interest? In other words, someone else will be making all the decisions about how to invest the cash.

The Background: Under a fair market value standard, a hypothetical seller would be reluctant to accept less than dollar for dollar value. However, a hypothetical buyer would consider many investment alternatives and may require some incentive to buy a 75% nonvoting interest.

One way to analyze the problem is to make comparisons with closed-end funds, which often trade at discounts to their net asset value. These are relatively liquid investments, wherein investors give control to a third party to manage their assets.

An article in the April 2007 Journal of Finance (pdf) posed the question, “Why would investors buy a closed-end fund at its IPO, knowing that it is likely to fall to a discount, when they could instead buy an open-end fund that is guaranteed always to trade at par?” The study concludes that managerial ability may be a significant factor. However, they also note that “The inability of economists to answer this question has led many to conclude that investor irrationality is the only possible explanation.”

The Bottom Line: Even seemingly simple valuation assignments unearth all kinds of interesting issues. A dollar may not be worth a dollar when someone else controls it…

Further Reading: Forbes and Kiplinger had interesting articles last year on the topic of closed-end funds and discounts:

• Outrageous Opportunities in Closed-End Funds (Kiplinger.com; October 15, 2008)
• Closed-End Funds At Deep Discounts (Forbes.com; July 30, 2008)