What is a Control Premium?

A control premium is the excess paid by a buyer over the market price of a target company in order to gain control. This premium can be substantial when a target company owns crucial intellectual property, real estate, or other assets that an acquirer wishes to own.

When investors purchase stock in a business, they gain the right to dividends, any appreciation in the market price of the stock, and any final share in the proceeds if the business is sold. If an investor buys at least a 51% controlling interest in a business, then it also obtains the right to redirect the business in any way it chooses. Consequently, obtaining a controlling interest is worth an additional price, which is called the control premium.

How Large is a Control Premium?

The control premium can be an insignificant issue if the target is on the verge of bankruptcy, since the presumably short-term nature of the business makes the control premium essentially irrelevant. However, if the target is a robust business that can be enhanced by the acquirer, then the control premium can be a significant factor. Historical evidence shows that control premiums for healthy businesses can range from 30% to 75% of the market price of a company’s stock.

Example of a Control Premium

The control premium is not a black-and-white concept, where the first 51% of ownership is more valuable than the remaining 49%. Instead, consider the multitude of situations where ownership is split among many owners. For example, what if there are three shareholders, with two owning 49% and one owning 2% of the shares? In this case, the 2% shareholder owns an extremely valuable piece of the business, given its ability to impact votes, and which would certainly command a premium. Alternatively, what if there are hundreds of small shareholders and one shareholder who owns 35% of a business? Owning that 35% might not result in outright control of the business, but it may be so much easier to obtain in comparison to the pursuit of hundreds of other shareholders that it commands a premium.

Advantages of a Control Premium

There are several advantages to paying a control premium for a business, which are as follows:

Enhanced closing speed. Paying a control premium allows the acquirer to complete an acquisition deal in short order, since it will have the support of the investors holding a controlling interest in the target company.
Gain operational control. Paying a control premium allows the acquirer to rapidly gain control over the operations of the target company, which allows it to alter operations in such a manner that it can recoup its investment. The acquirer can now influence the company’s direction, strategic objectives, and day-to-day decisions without needing to rely on existing management.
Improved financial flexibility. Paying a control premium gives the acquirer more financial flexibility, such as the ability to implement new capital structures, take on new debt, or reinvest profits in strategic projects.
Control over corporate governance. With majority control, the acquirer can influence or appoint board members, executives, and key decision-makers, ensuring that the company’s leadership aligns with its long-term strategic objectives. This is a significant issue when the target company previously had weak governance structures.

The Control Premium in a Two-Tier Acquisition

The control premium concept is a key reason why acquirers sometimes reduce their offer prices for any remaining shares outstanding in a two-tier acquisition. If an acquirer has already attained control over a business, there is no longer a control premium associated with any additional shares, which therefore reduces their value.