Shareholder Rights - Valuing a Shareholding

Valuing Shareholdings

Background

In a Private Limited Company, it is never a precise science to arrive at an accurate valuation of the company. It is always entirely possible that different accountants would arrive at different valuations in exactly the same factual circumstances. The position might well be equated to trying to value land or property. What it is worth to one person may well be something different to what it is worth to another person. However, in almost every case, the most appropriate individual to decide upon the value of any given shareholding will be a suitably experienced and qualified accountant.

The Basis of a Valuation

There are essentially two different ways to value a company (and therefore a shareholding in that company).

A valuation based on a “net asset” basis will focus on the value of the assets owned by the company which might well be, for example, property or plant and machinery. In contrast, an “earnings” based valuation would concentrate on the income and earnings generated by a particular company both historically and the potential to earn income in the future.

It is normally a matter for the valuer to decide which of these bases is the most appropriate in any given circumstances. Certain companies may well strongly favour a net asset based valuation (such as property investment companies) and other companies will more obviously lean towards an earning based valuation (for example, an internet based retailer with little or no assets).

Minority Shareholder Discounts

The possibility of the value of any minority shareholding being discounted for the very fact that it is only a minority shareholding is discussed under the “Selling Your Shareholding” section. Obviously, the question of a discount does not arise where the shareholding to be valued is a majority shareholding.

In most cases where a minority shareholder wishes to voluntarily sell his shareholding in a company, a discount will be applied to reflect the fact that the shareholding does not represent a majority (and therefore does not enable the owner to control the company). However, where a minority shareholder is in effect being “forced” to sell his shares or is left with no alternative but to force the majority shareholder to purchase his/her shares, it may well be inappropriate for any valuation to “punish” the minority shareholder by applying a discount. Most commonly, this situation will arise during the course of a dispute between shareholders in a small limited company. Where a minority shareholder is forced to resort to legal proceedings against a majority shareholder (see the “Shareholder Disputes” section), he or she will normally seek an order of the court that the shareholding should be bought at a full value, namely without any discount being applied for the fact that it is a minority shareholding.

The Date of Valuation

Often, the date upon which a company or a shareholding in a company is to be valued can have a significant affect on the outcome of the valuation. Where the buyer and seller have agreed the date of the valuation, there is normally no difficulty. Similarly, where a sale occurs as a result of provisions set out in a company’s Articles of Association, there is normally no argument on this issue.

However, where a valuation arises as a consequence of a dispute between shareholders (for example, because the court has ordered one party to purchase the shareholding of the other party), the question of the date upon which the valuation should be carried out becomes an important consideration.

From the valuer’s perspective, the easiest date to work from is normally the company’s year end, when there may well be accounts which have already been professionally drawn up. Obviously, these provide a useful reference point for any valuation, but it may well be that the date of the company’s financial year end, as a date at which to value the Company, is far more advantageous to one shareholder than it is to another.

Take, for example, the position where two people are in business together as equal 50% shareholders in a Limited Company. The Company is successful and as at the financial year end of 31st December, the latest available Company accounts show a very healthy position. However, midway through the current year, one of the shareholders leaves and sets up his own competing business in exactly the same field, seeking to deal with the same customers and the same business. The net effect of this is to divide the customer base, drive down profitability and generally devalue the Company. However, a valuation of the Company carried out at the date of the last available year end accounts would not reflect the true position and would substantially overvalue the Company and any shareholding in the Company.

Generally speaking, the court’s attitude to this position is that the appropriate valuation date is a date which is as close as possible to the actual date of sale, so as to best reflect the value of what the shareholder is selling. Accordingly, the normal valuation date chosen by the court where there has been an order for shares to be bought out at an independent valuation, will be the date of the court order itself. However, the court will remain mindful of any unfairness that may result from applying this general principle.

Compensating Adjustments

In the shareholder dispute scenario, valuing a company or a shareholding may also be complicated by the misconduct or wrongdoings of others. For example, a company director might have entered into a contract which involves substantial and excessive payments to himself or a member of his family. That contract is obviously disadvantageous to the company and devalues the company itself. In the circumstances of a dispute between shareholders, the court has the power to order that a valuation should take place on the hypothetical basis that such a contract had never been entered into - in effect, making a “compensating adjustment” for the wrong doing in question.

“Fair Value”

Again, the question of “fair value” is discussed in the “Selling Your Shareholding” Section. In most situations where there is a need to value a company or shareholding, the valuer will be asked to arrive at a “fair value”. This may be because the company’s Articles of Association direct that a “fair value” should be determined or because a court has directed that a “fair value” should be determined.

There is no judicial definition of what constitutes “fair value”. The starting point in determining what factors should be taken into account in determining a “fair value” is the company’s Articles of Association. Often, the Articles will themselves set out what is meant by the term “fair value”. Equally often however, the Articles will be silent on the question. In the context of a shareholder dispute, potential argument over precisely what is meant by “fair value” can often be foreseen and the court has a wide power to direct what factors should be taken into account in determining any “fair value”.

In the absence of any other guidance, precisely what constitutes a “fair value” is likely to come down to whatever the appointed valuer considers is appropriate.

Identifying a Valuer

Choosing the identity of a valuer can have a significant impact upon the ultimate valuation arrived at. It is always important to identify an appropriately qualified valuer who has experience of not only the relevant industry in which the company operates but also has experience of dealing with companies of that size and type. Practical considerations, such as the cost of the valuation, are also of obvious relevance.

Whenever the question of identifying a valuer arises, it is normal for at least one or other party to suggest that the company auditors or accountants should carry out that role. This has obvious attractions in that the company auditors/accountants will be fully familiar with the company already and this in itself will also help to keep down costs. However, in practice, it may well be that the company auditors/accountants cannot be truly independent or, at least, cannot be seen to be truly independent as they may well (consciously or sub-consciously) have a natural allegiance in favour of whichever individual(s) will remain in control of the company after the valuation. After all, they will be the individual(s) who will determine whether or not the auditors/accountants are reappointed in future years.

In the absence of any agreement on the identity of a valuer, the most appropriate course of action is normally to agree that the parties should ask the President for the time being of the Institute of Chartered Accountants in England and Wales to independently identify a valuer and for the parties to be bound by his/her decision.

If you are looking for a suitable valuer, experienced in valuing Companies and shareholdings, why not contact us and we will be happy to suggest an appropriate valuer to you.