Partnership and Shareholder Buyouts
Center Point has worked with a number of firms whose partners or shareholders required a valuation for the purpose of understanding the value of the business and/or a specific shareholder interest. The valuation has been used by the shareholder that has engaged our firm either to buyout the other shareholder(s) of the firm, offer to have the other shareholder(s) buy them out of the firm, or remain a shareholder of the firm in an active or passive manner. A valuation has proven especially useful in 50/50 partner situations where the partners are deadlocked and neither partner has control over major company decisions.
We have worked on buyout valuations on a "friendly" and "litigious" basis and both environments have significant valuation considerations. The factors that can drive major assumptions used in the valuation are: applicability of control and marketability discounts under fair market value, buy-sell agreements, operating agreements, and legal statutes regarding fair value of a business that vary from state to state.
Frequently, shareholder buy-outs are addressed in a company's operating agreement or in a separate buy-sell agreement. Too often, though, the specific provisions of the agreement that pertain to how the purchase price is set are vague. Formulas are subject to interpretation and are often too narrow to cover all relevant valuation methods and considerations. We recommend that your agreement provide for a credentialed appraiser to quantify the buy-sell price, because an independent, qualified party can consider all the relevant factors that go into determining an appropriate price.
If you already have an agreement, or are in the process of drafting one, review the exact wording pertaining to price. Most agreements have language that is non-specific and difficult to interpret. Appraisal language is specific, and certain words mean certain things. For instance, fair market value frequently includes consideration of discounts for lack of control and lack of marketability. What this means to a minority shareholder is that the value of the ownership interest in the company will be discounted from the pro rata value of the entire business. If that is not the intent, it should be specific in the agreement.
If you are in the unfortunate position of approaching litigation or you are already involved in litigation, there are several things you should consider. Have an appraiser review the provisions of your agreement to identify any areas that pertain to pricing to determine if the terms are specific to the valuation and accounting field. And, finally, ask an attorney for guidance on what the laws are in your state pertaining to minority shareholders. Some states specifically provide for no discounts, while others mandate them.
In California, the applicable statute for fair value is California Corporations Code Section 2000.
This statute is invoked by a corporation to stay the proceedings of an involuntary dissolution of the company that is initiated by one or more shareholders under Section 1800. Under Section 2000, the corporation or the purchasing parties may avoid dissolution of the corporation by purchasing the shares of the dissenting shareholders. The court appoints three disinterested appraisers to establish the fair value of the shares. An appraiser must understand the implications of the definition of fair value set forth in the statute and the substantial case law that controls the area of corporate dissolution to properly value a company under the statute.