Business valuation issues are often front and center in a wide variety of civil litigation matters. For example, business valuation issues can arise when determining the value of a departing owner’s interest in a business entity or when dividing community property assets. Whether attacking an opposing expert’s valuation methodology, advocating for a favorable remedy for a plaintiff, or persuading the Court in relation to the appropriate valuation standard to be applied, the nuances of business valuation concepts present a host of complex issues and pitfalls for the unwary practitioner.
A Continuum of Different Business Valuation Standards
There exists a wide continuum of different valuation standards. At one end of the spectrum, is the liquidation valuation standard which assesses the value based on either an orderly sale or quick sale of the business assets. At the other far end of the business valuation continuum, is synergistic value which takes into consideration the enhanced value from the combination of new assets which have a higher value than the sum of the individual assets.
Between these two extremes, are other more common business valuation standards, such as fair market value, fair value and investment value. The application of these valuation standards can yield considerably divergent valuation conclusions. As such, it is imperative that a business valuation appraiser be given a clear valuation assignment that includes an identifiable business valuation standard. As the example described below demonstrates, the absence of clear valuation assignment parameters can lead to ambiguity and ultimately to disputes about business valuation standards.
The Need for Certainty as to the Appropriate Valuation Standard to be Applied
The Louderback Law Group was recently involved in a dispute involving the valuation of a departing shareholder’s interest in a closely held corporation in the technology services industry. The dispute centered around the interpretation of language in the corporation’s shareholder agreement which established a procedure triggered by the departure of a shareholder for appointed appraisers to ascertain the value of the departing shareholder’s ownership interest. Here, the shareholder’s agreement was drafted in an ambiguous manner and failed to specify which valuation standard was to be applied. Adding to this ambiguity, the definition of various standards of value can vary between jurisdictions and even between different professional accounting and valuation societies. Accordingly, a contractual instrument that sets forth a mechanism for conducting a business valuation should identify the specific valuation standard to be applied with reference to a discernible authority for guidance.
Without guidance as to the appropriate valuation standard to be applied, the two appointed appraisers applied different valuation standards which resulted in widely disparate valuation conclusions. Notably, the appraisers’ divergent valuation conclusions were a result of the inconsistent application of minority and marketability discounts. A minority discount is applied to compensate for a lack of control of the corporation and a marketability discount is intended to compensate for difficulties associated with liquidating the assets of private and closely held corporations. The application of minority and marketability discounts to the valuation of a closely held corporation can have an enormous impact on the final valuation conclusions.
In this matter, the ambiguity and lack of guidance as to the appropriate standard of value to be applied in the shareholder’s agreement opened the door for various compelling arguments on behalf of our client. First, we argued that at the time the shareholder’s agreement the parties did not intend for minority or marketability discounts to be applied, and the parties’ intent was controlling in the absence of clear guidance in the shareholder’s agreement. We also highlighted the parties’ conduct after the shareholder’s agreement was executed as further proof that the parties had intended for an equal distribution of all assets.
Further, we relied on California law to support our client’s position that the application of a minority or marketability discount was improper. California law has repeatedly rejected the application of a minority discount in the context of corporate dissolution proceedings involving closely held corporations because doing so could contribute to the oppression of a minority shareholder. Additionally, California courts have found that a discount for lack of control is inapplicable when the shares are being purchased by someone who is already in control of the corporation or by the corporation itself. We relied on these authorities to argue that the application of a minority or marketability discount would lead to an inequitable result. In addition to these arguments, we were able to attack the opposing appraiser’s valuation report in relation to its input data, methodology and conclusions.
A Successful Result for Our Client
Ultimately, we were able to obtain an excellent result for our client. As this example demonstrates, experienced legal counsel is critical to navigate the complexities and nuances of disputes involving business valuation issues. A comprehensive understanding of these concepts can ultimately be the difference between a successful and unsuccessful result.
This content is made available by Louderback Law Group for informational purposes only, not to provide specific legal advice. This information contained herein should not be used as a substitute for competent legal advice from a licensed counsel.