Taxation & Valuation of Share Premiums

November 2023

Control Premium

Control Premium, as the name suggests, refers to the amount paid by an acquirer for acquisition of a controlling stake in an entity. Control Premium has traditionally been a subject matter of negotiations. Practically, the same would depend on a combination of various factors like synergies in the hands of the acquirer, barriers to entry, barriers to exit, market positioning of the Target, etc.

A premium for control is warranted as on acquisition of a significant stake, the acquirer would be able to have an influence on several operating and financial decisions of the Target entity. This influence could be in the nature of regular day to day operations, financial decisions – say determining optimum level of debt, appointment of board of directors, major expansion/curtailment policies, a seat or influence on the board of the Target, etc. A premium for control would also depend on the business prospects of an entity, for example - in case of a distress sale, the seller may not be able to negotiate for a control premium.

In an ideal scenario, the value of control would be value of an optimally controlled entity less that of the entity on a status quo basis. It would typically be a function of the stake acquired and the consequent control obtained. Further, there could a range of control premium given the quantum and percent of stake acquired – for example - a 10% stake would typically come with a board seat, a stake of 25% would in addition also have the power to stop a special resolution. 

The statues in India, especially in the recent times have also given cognizance to a premium for control. The Valuation Standards issued by the Institute of Chartered Accountants of India in ICAI Valuation Standards 103 on Valuation Approaches and Methods specifies that the valuer shall apply professional judgement while applying control premiums and discounts for lack of control, considering the factors such as amount/ extent of control in the asset to be valued, distribution of control of the remaining interest in the subject entity, statutory provision relating to protection of minority shareholders; the shareholder protection restrictions contained in the articles of incorporation, the bye-laws and/or the shareholders’ agreement, blockage discount, etc.

The SEBI amended its SEBI (Issue of Capital and Disclosure) Regulations, 2018 (“ICDR Regulations”) in January 2022. The said ICDR Regulations typically apply in case of a preferential issue of equity shares by a listed entity. Pursuant to the amendment, in case of a change in control pursuant of the issuer, the valuation report from a registered valuer (in accordance with ICDR Regulations – Regulation 166A) shall also cover guidance on control premium computed over and above the price computed with respect to the said regulations. 

The takeovers of listed entities in India are governed by SEBI (Substantial Acquisition of Shares and Takeovers), 2011 (“Takeover Regulations”). These regulations are an important inkling to assess the range of control premiums paid in cases of commercial negotiations. Takeover Regulations by nature, are triggered in case of change in control or creeping acquisition of more than 5% by existing promoters (already holding 25%) in one financial year. The said regulations list down several parameters for assessing the open offer price including the price paid as a result of commercial negotiations between the buyer and seller, the 60 days volume weighted average market price in case of frequently traded listed companies, acquisition price by the buyer in previous 52 weeks, etc. The open offer price is highest of the several prices listed in the said regulations.

We have analysed some open offers in the listed space. Based on our analysis, we note that the average control premium for frequently traded stocks is ~ 8.5%. 

Below chart gives a broad overview of our analysis.

 The above analysis is after removing outliers (especially considering the base effect.)

The Banking Services space showed the highest number of deals in FY 2023 with an average control premium ~17%. The highest control premium in our analysis above is a premium of ~ 36% to the base market price.

The premium for control is subjective and would be dependent on factors of each case listed hereunder: -

∞ Business of Target entity- Regulators of business may have specific restrictions of change in control.

∞ There may be trade-offs involved w.r.t change in control, like no tax benefit available if the stakeholders of combined entity undergo change.

∞ The relationship of existing management with various business stakeholders may cause resistance for effecting change in control.

∞ Company charters may have laid down elaborate procedures for avoiding change in control. 

All the above factors would play a key role in determining the quantum of premium for control.