I recently re-watched Planes, Trains and Automobiles, the 1987 comic odyssey starring John Candy and Steve Martin. When the two exhausted road warriors (Candy and Martin) try to check into the last remaining motel room in town, the manager tells them they’ll have to share it. As a consolation, he tells them: “I’ll have to charge you for a double, but with the discount it’ll come out even!”
Even when it’s not the holiday season, I find that consumers often misunderstand discounts. The same goes for many practitioners when it comes to company ownership and control. The discount for lack of control (DLOC) and its big brother, the discount for lack of marketability (DLOM), are often confused or worse, ignored. That can have significant consequences down the road.
DLOC vs. DLOM
To get up to speed on DLOC, you must first understand factors of control. Control is generally defined as one’s ability to dictate or influence to a significant degree, a company’s operations, decision making, and corporate finances. Those actions are usually determined by governing documents such as a shareholder or operating agreement. That agreement empowers owners holding a majority of ownership interests to manage the company—or to nominate a manager or executives to do so.
In many small business cases (as we’ll see below), “ownership” often nominates a small group of owners to serve as the company’s management team. This gives the management team the power to decide how operations are executed. It also gives them the power to sign or alter leasing and financing arrangements, to determine salaries and bonuses or to determine capital available for distributions or dividends.
Factors of marketability are similar to factors of control described above. That’s why we typically see DLOC and DLOM applied together. Marketability is simply the ability to create liquidity. Liquidity can be achieved through a yield, such as through distributions or through a liquidity event, such as a sale of an individual ownership stake or all of the company’s equity. As with other corporate decisions, a majority ownership interest (or management that the majority elected) decides whether to make distributions to shareholders and approve the transfer of equity.
Treehouse Brewing Company Dispute
Allegations in the recent ownership lawsuit involving the wildly popular Tree House Brewing Company (THB), the nation’s largest direct-to-consumer on-premises brewer, perfectly illustrate DLOC and DLOM issues in the real world. Even in very successful companies such as THB, controlling interest holders, or a faction of stakeholders that has gained collective control, could leave minority interest holders out in the cold. Typically, the controlling position creates liquidity for itself through means other than distributions or dividends, which could be received on a prorated basis by the minority position. How? By taking above-market salaries or by leasing from a related party entity in which the minority position doesn’t own a part, for instance. Both of these tactics were alleged in the suit involving THB.
Eric Granger, a 2% minority shareholder in THB, filed the lawsuit last November against both the company and the two controlling owners, CEO Nathan Lanier and President Damien Goudreau. Lanier and Goudreau each held 49% of the company.
Granger alleged that he invested in the company in 2012 and claimed his interest was converted in 2015 to non-voting shares. Meanwhile, Lanier and Goudreau were the only ones to receive voting shares. Granger accused the founders of paying themselves excessively, concealing real estate purchases and buying luxury vehicles in lieu of paying dividends that should have been shared with minority shareholders.
According to the lawsuit, Lanier and Goudreau formed separate limited liability companies to purchase property and lease the property back to THB. Granger alleged that one of those LLCs had real estate holdings valued at over $13 million, including a single-family beachfront home adjacent to the brewery in Sandwich, Mass. The suit claimed further that THB paid nearly $10 million in lease payments to the two LLCs. “The leases were created to divert corporate assets away from Tree House,” the lawsuit stated.
According to the suit, Lanier and Goudreau also paid themselves “excessive officer salaries and bonuses” while not offering commensurate financial rewards to the minority shareholders. Starting in 2018, Granger alleged the two purchased a series of ultra-luxury vehicles for their use and for family members.
For discussion purposes, let’s assume there’s merit to Granger’s claims. THB is a very profitable and valuable investment for a controlling owner. However, in a minority owner’s hands, the investment is much less valuable. That’s an example of the difference between DLOC and DLOM. Unfortunately, most operating agreements allow for this exact scenario. Minority shareholders like Granger can get left out in the cold like an abandoned beer keg on a Sunday morning.
Granger claims he’s receiving minimal distributions from THB (and remember that he also incurs a tax bill based on the income of THB). Granger could agree to sell his shares to his fellow owners amicably, although that’s unlikely given their strained relationship and certain allegations. Or he could sue them, hoping to recoup a value closer to a controlling position. The lawsuit would mean cash out front and the probability (perhaps low) of receiving cash on the back end.
Effect on Estate Planning
A table saw is a great tool for carpentry but can easily remove your digits too. We’ve seen how an owner can be harmed by DLOC and DLOM, so how could we use DLOM and DLOC safely and effectively for estate planning and implement discounts through efficient and authentic wealth transfers?
Example: John Doe owns 100% of Pillow Fort Brewing (PFB), a successful craft brewer. His controlling equity interest has been appraised at $50 million. Doe has great foresight and is concerned about his potential estate tax bill. Additionally, he’s been hearing about the upcoming estate tax exemption sunset in 2026 and wants to use its elevated level while he still can.
After consulting with an estate planning expert, Doe learns he can gift pieces of his stock in PFB to his children. If he does so in minority blocks, he can take advantage of both DLOC and DLOM to reduce his estate tax hit. Like many owners, Doe runs some discretionary expenses through PFB including an above market rent for the operating facility which he owns through a separate LLC. The appraiser adjusted for this fact on a controlling interest basis by restating rent to a market level. This is something that Doe can do at his discretion as a controlling shareholder, but not as a minority interest holder, per his operating agreement. Without these adjustments, Doe’s equity value, on a non-controlling basis, would be around $45 million.
Additionally, Doe benefits from the ability to declare distributions at his leisure. He can even sell the company without needing input from anyone else, that is, making his situation fully marketable. His operating agreement restricts a minority interest holder from doing either of these maneuvers. After an analysis, Doe’s non-controlling, non-marketable basis equity value was reduced to $30 million from $45 million by using DLOM.
Doe and his wife make minority gifts PFB valued at $28 million (using all of their federal lifetime exemption) through 2024 and 2025. Through that, Doe paid nothing in federal gift tax and reduced his potential estate tax on Jan. 1, 2026, by upwards of $5 million ($14 million worth of expiring exemption, which will be worthless after 2025 x 40% = $5.6 million.
An effective strategy and thoughtful execution allowed Doe to pass on significantly more wealth to his family and preserve his legacy for generations. The benefit could be even larger given Biden’s recent Green Book proposals. But Doe was only able to capitalize on DLOM and DLOC by engaging a skilled advisor.
NOTE: This article is for illustrative purposes only. I have no knowledge of THB, its financial results, its ownership group or the specific allegations involved. Nor do I have any knowledge as to whether those allegations would indicate any civil or criminal penalty should be due.
Anthony Venette, CPA/ABV is a Senior Manager, Business Valuation & Advisory, DeJoy & Co., CPAs & Advisors in Rochester, New York. He provides business valuation and advisory services to corporate and individual clients of DeJoy.
