Breaking Up Is Hard to Do: Business Valuation in Owner Disputes
- Nov 22, 2019
- Hubert Klein
While most business owners begin their entrepreneurial journeys with the best of intentions, owners simply won’t agree on everything all the time. Considerable disagreement can often lead business owners to end their relationship and go their separate ways. And whether the owners have a 50/50 relationship or one of them has a minority interest, there could be a scenario where one of them feels disadvantaged. This can be especially true when an owner or group of owners believe controlling shareholder decisions negatively impacts them. When an owner feels the odds are stacked against him or her, they may turn to a legal remedy to dissolve the business venture. These remedies include litigation, alternative dispute resolution or judicial solution.
Most dissolution disputes center on the valuation of the business. One of the first steps in the process is for the owners to determine how much the business is worth so that they can arrive at an equitable resolution, such as buying out the other’s interest or selling the business to a third party.
However, valuing an owner’s interest in the business is difficult because it requires a unique type of expertise in valuation theory and methods, along with the application of generally accepted valuation principles. Most business owner disputes are classified and valuations are prepared according to value standards identified prior to the appraisal. Business owner disputes can generally be classified as:
- Dissenting shareholder actions
- Minority oppression actions
- Disassociation actions
- Statutory mergers and appraisal rights valuations
- Other matters guided by documents and contracts
- Partner/shareholder disputes
- Loss of business value disputes
- Post-merger and acquisition disputes
- Marital dissolutions
Some common triggering events for owner disputes are:
- Deceptive practices
- Diversion of corporate opportunity
- Diversion of income
- Involuntary dissolution of a business
- Non-payment of distributions
- Breach of contract
A business valuation professional’s mission is to provide unbiased, third-party opinions of business value for his or her client. This expert may be asked to identify key valuation issues, assess the magnitude of various aspects of a case, and/or prepare valuation reports.
Where the business valuation professional really earns his or her stripes is identifying the proper appraisal methodology to use in each case. Generally, most accepted value appropriations are developed from state statutes and case law in a particular filing jurisdiction and include fair value, fair market value, intrinsic value, and investment value.
Fair Value Versus Fair Market Value
In many jurisdictions fair value—while not always clearly defined—is the most widely applied standard. In most states, fair value is generally defined as: “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.”
Fair market value, on the other hand, is still used in some jurisdictions. It allows valuation discounts for marketability or minority interest. In some instances, both discounts may be applicable. Applying the proper standard of value and knowing whether or not discounts are appropriate can have a significant impact on the valuation expert’s conclusions.
Fair value is generally 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.
- It applies to minority blocks.
Fair market value tends to be considered when:
- The 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.
Depending on the jurisdictions and valuation, discounts may be appropriate and applicable. Always consult your legal advisor to determine what would best apply to your situation. Generally, all other things being equal, value discounts are the main difference between fair value and fair market value. There is a (1) discount for lack of control; (2) discount for lack of marketability. The proper application of discounts in a business valuation is generally covered by jurisdiction case law and/or statutes.
The Choice Is Yours
Business owner disputes often occur during a time of great stress. And depending on the issues involved, different value standards and discounts may or may not be applicable. This is why it is paramount to use an experienced and skilled valuation expert to safeguard your interests in a business that is being dissolved.
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Hubert Klein a Partner, the Firmwide Valuation Services Leader, and the New Jersey Forensic, Litigation & Valuation Services (“FLVS”) Market Leader, is a nationally recognized expert witness and professional educator in forensic accounting, damages, and valuation topics.
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