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Understanding Valuation Issues During a Shareholder Dispute

Valuation Issues

It is a sad fact of business that shareholders in a corporation may not all agree on an action the company is about to take. Those who hold a minority number of shares can feel mistreated or may disagree with decisions made by the controlling shareholder and wish to depart the partnership or ask for the corporation to be judicially dissolved.

At the heart of the shareholder disputes is the valuation of shares, the determination of how much the shares are worth at a point in time so that an equitable sale can be arranged.

Valuation is a difficult task that requires significant levels of expertise in generally accepted valuation principles and application. Disputes are classified and valuations prepared according to standards of value identified at defined before the appraisal. 

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Shareholder Dispute Classification

Shareholder disputes are classified as:

  • Dissenting shareholder actions
  • Minority oppression actions
  • Other matters guided by documents and contracts

Dissenting shareholder actions are about the “appraisal rights” provided to minority shareholders. Appraisal rights allow dissent from extraordinary corporate actions that could negatively affect minority shareholder interests. Triggers include mergers, the sale of assets, or the exchange of shares.

Minority oppression actions are seen in corporate dissolution statutes and allow the minority shareholders who have been “oppressed” to file for judicial dissolution of the corporation. Triggers include illegal, fraudulent, or oppressive acts by majority shareholders. It can also apply to actions that waste or misapply corporate assets.

Valuation disputes can involve:

  • Bankruptcy
  • Partner/shareholder disputes
  • Loss of business value disputes
  • Minority shareholder oppression
  • Post-merger and acquisition disputes
  • Marital dissolutions
  • Statutory mergers and appraisal rights valuations

Common triggering events: 

  • Deceptive practices
  • Diversion of income
  • Involuntary dissolution of a business
  • Non-payment of distributions
  • Breach of contract

Share Valuation

Appraisers attempt to give unbiased, third party opinions of value for the shares in dispute. They may be asked to identify key valuation issues, assess magnitudes of various aspects of a case, or prepare expert valuation reports, among other things.

Above all, they assist in identifying and defining the right standard of value to use for the appraisal in each dispute case. Most value appropriations are developed from state statutes and case law in the filing jurisdiction.

Generally accepted standards of value include:

  • Investment value
  • Fair cash value
  • Fair value
  • Fair market value

Of these, fair value is the most widely applied although it is not always clearly defined. It is easily confused with fair market value, which has a different definition. Fair value in most states is defined using the 1984 version of the MBCA (Model Business Corporation Act). 

“Fair value with respect to the dissenter’s shares means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding the appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.”

In 1999 the MBCA was updated to include a clause disallowing the use of value discounts to obtain the value for minority interests. However, most states have not updated their statutes to match and still rely on the 1984 definition in which case they may consider value discounts in the valuation.

Fair value tends to be considered when:

  • Buyer and seller are both willing
  • Neither are under any compulsion to buy or sell
  • The valuation assumes a typical hypothetical buyer and seller
  • Price is equitable to both
  • Assumes the buyer and seller have equal and reasonable knowledge
  • The valuation is applicable to controlling interests or minority blocks
  • The valuation applies to all federal tax valuations

Fair market value, on the other hand, is used when:

  • The seller is not willing and the buyer may or may not be willing
  • The buyer is not compelled but the seller is always under compulsion
  • The impact of the proposed transactions are not considered but the concept of fairness to the seller is a potential consideration
  • Instead of an equitable price for both, the concept of fairness is considered for the seller due to the inability to keep the stock
  • No assumption is made about equal or reasonable knowledge of both parties
  • Applies only to minority blocks

Fairness is a concept argued when there is no definitive statute or relevant case law. Absolute fairness, usually argued by the buyer, infers that the consideration received was adequate relative to the value of the interest that was given up. Relative fairness, argued by the seller, is about whether the consideration received was fair in comparison to what the other shareholders received.

Value Discounts and Date/Time Issues

Value discounts are the main difference between fair value and fair market value.

  • Discount for lack of control (DLOC)
  • Discount for lack of marketability (DLOM)

Applicability of the discounts varies among the states.

Business valuations are an estimate of value determined at a particular point in time. Dissenting shareholders prefer fair value to be determined as of the day before the meeting in which the proposed action was dissented. Minority oppression disputes determine fair value as of the date of the commencement of the oppressing action. Rules vary between jurisdictions and the type of dispute.

Valuation of shares is a difficult task undertaken during a time of shareholder duress. Depending on the issue, different standards of value may be used and value discounts may or may not be considered. The dispute tends to originate with minority shareholders who disagree with a corporate action and wish to leave the partnership. Therefore, the shares must be sold and the departing member recompensed.

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