Does a minority interest in a company have greater value because it could be seen as a potential "swing" interest in obtaining control through alliance with another minority interest holder?

The IRS has suggested the swing vote premium as a factor offsetting minority discounts in estate and gift tax valuations. But the concept is disputed by many valuation experts, who point out the chance nature of an alliance that would give the minority interest extra value. Others are willing to concede that such a premium may exist in very specific circumstances, determined by the facts of the individual case.

The IRS made the argument for a swing vote premium in a 1994 technical advice memorandum (TAM 9436005). The memorandum addressed discounts to be allowed on simultaneous gifts by the owner of 100 percent of a corporation’s outstanding common stock to his three children and his spouse. The owner transferred 30 percent ownership to each of his three children and 5 percent to his spouse and claimed combined discounts of 25 percent of net asset value for lack of control and marketability.

The IRS focused on the potential of each of the three children to join with one of the others to exert control over the corporation. The TAM also suggests that the timing of the transfers is irrelevant. Even if the gifts had been at separate times, making the first 30-percent gift a minority block with no swing vote potential, as soon as the second and third stock blocks were transferred, the value of the first gift would be enhanced, according to the IRS.

Fair Market Value
Critics of the swing vote concept see a conflict with the IRS definition of fair market value — "the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts."

That definition was further narrowed in May of this year, in a case involving the value of minority interest voting shares compared to nonvoting shares. In Estate of Simplot v. Commissioner, the Ninth Circuit federal appeals court ruled that a "purely hypothetical willing buyer and seller" were required to set fair market value, rather than "specific individuals or entities."

A minority interest owner seeking to form an alliance with another minority interest owner to gain control is not the hypothetical buyer — or seller — described in the definition, according to critics of the swing vote premium. The uncertainty of such an alliance makes it irrational to use its possibility as the basis to set the value of the gift, they say.  

Opportunities and Problems
Others advocate the existence of a swing vote premium under circumstances involving a specific need to create a controlling block of stock, either to take advantage of an opportunity or to solve a problem. Under this view, for example, value may increase for minority shares of a corporation with bylaws requiring a supermajority to approve sale of the business, if there’s a written offer to buy and no shareholder holds sufficient interest to approve the sale. Under these circumstances, proponents argue, the premium is created
by a specific opportunity affecting the value of the stock.

Another situation that may call for limited application of a swing vote premium involves the need to replace inept management when no shareholder holds a majority interest. In this example, key elements would be bylaws permitting election of directors by a majority of voting shareholders and a slate of individuals with the declared intention of replacing the management team. According to supporters of the notion of a carefully defined swing vote premium, the minority blocks of stock gain value because they can help solve a problem when combined into a controlling block.

Application of a swing vote premium, even under such carefully circumscribed conditions, requires careful consideration of applicable state law.