Valuing Shares
Many people will have seen details in the press of the dispute amongst the shareholders of the Gadget Shop which has led to the Company ceasing trading, the start of proceedings to wind up the Company and a Section 459 action for prejudicing the rights of a minority shareholder. Ceasing trading and winding up the Company is the last resort when directors and / or shareholders disagree on the strategy and direction of a business.
What is more commonly seen is that the shareholders will agree for some of them to buy out the others so that the business continues. This sounds very straightforward but when the price negotiations start it can often be when the fun and games commence because, unsurprisingly, the estimation of the value of a Company often varies wildly between the party selling the shares and he who is buying!
It is common for companies to have deadlock provisions in the joint venture / shareholders’ agreements and / or Articles of Association in order to resolve disputes between shareholders so that the Company can continue to trade. As mentioned above, it is usually the last resort for the Company to be wound up and the preferred option, which maintains the value of each party's investment, is for one party to sell out to the others. Many different methods of doing this have been devised including the so-called:-
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Russian Roulette – the offering shareholder gives notice of a price per share which the other shareholder either accepts or can buy shares from the offering shareholder at the same price, and
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Mexican Shoot-off – which can include blind bids being placed in envelopes with the highest bidder winning.
It is certainly the norm in most joint ventures for the parties to agree in advance a mechanism whereby one shareholder can be bought out. If so, it is vital to insert a process to determine the price because there is a good chance that the parties will be far apart on what they consider the shares are worth.
To illustrate, a typical clause for valuing shares for any transfer where the parties cannot agree a price and so appoint a third party expert to decide the matter may contain the following provisions:
"The Expert shall be asked by either the directors or the Vendor to certify in his opinion the fair value of the transfer shares on a going concern basis as between a willing seller and a willing buyer taking no account of any reduction which might otherwise be ascribed to the transfer shares by virtue of the fact that they represent a minority interest. The Sale Price per share shall be calculated by dividing the fair value of the Company calculated as aforesaid by the total number of shares issued in the Company and then multiplying it by the number of the transfer shares.”
Whilst the above may seem relatively straightforward, it is important to look at the terms used in more detail because it is these terms which must be interpreted, maybe ultimately by a court.
First, it should be noted that the parties have the opportunity to agree a mutually acceptable price and so the respective bargaining positions of the parties may be revealed in negotiations. For example, if the seller sets an unreasonably high purchase price then it is taking a risk that instead of accepting the purchaser’s value, the Expert will determine a price lower than the purchaser’s offer.
Secondly, of great significance is that an independent chartered accountant is likely to be appointed as an Expert and not an arbiter. What does this mean in practice? It means that instead of trying to reach a middle ground which is acceptable to both parties when considering the offers put forward by each of the seller and the purchaser, the accountant should take no consideration of what has been offered but instead calculate the price per share on the basis of the facts and circumstances of the Company in question. It can also be provided that both the seller and purchaser are allowed to make representations to the Expert to back up their valuation. It should always be the case that the Expert’s decision is final and binding on the parties.
It is also standard for the parameters for the Expert to be set by the Articles. In the example given above this includes:-
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Fair value – generally, “market value” has been deemed to be a price which an outside buyer, anywhere in the world, would pay for the shares. It also assumes that there is someone other than the existing shareholders who would wish to buy a stake in the Company. “Fair value” is often seen as being what the specific seller and purchaser involved would consider is fair, considering all their knowledge of the Company (which may not always be available to a third party purchaser) and specific circumstances (such as the previous behaviour of the shareholders).
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On a going concern basis – this is commonly interpreted as being that the Company will continue to trade. This may seem obvious, but there is the possibility that the Company has ceased or will cease trading, in which case it could otherwise be argued that no consideration should be taken of goodwill and so it is only the Company’s realisable assets which should be taken into consideration.
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Willing seller and willing buyer – this may seem obvious, however sometimes one party in a transaction is more eager to complete the deal than the other. More commonly the seller wants his money and fast, especially if he is retiring. Of course, a buyer can be equally keen to take control of a Company or simply get rid of a rogue shareholder. It is generally accepted that a willing buyer is someone who wishes to buy the Company but is not desperate to do so whilst a willing seller is also deemed not to be in any hurry to need the money from the sale. This means the Expert should assume that both parties will negotiate on normal commercial terms rather than compromise for a quick sale.
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No account of minority interest – this is a major consideration. If, for example, the seller is disposing of a 10% stake in a Company (and such shares have no special rights) to a party who owns 90% of the shares, then clearly the 10% stake is worth less due to the fact that the other party holds 90% and can change aspects of the Company in such a manner as to prejudice the 10% shareholder. The reason for not taking into account the minority percentage is to get a proportionate price per share and to avoid the potentially subjective opinion of the Expert as to the appropriate reduction in value of the shares because they are a minority holding. Instead the Expert calculates the value of the Company and treats every issued share as having the same value. This is, therefore, a very important aspect.
The final sentence of the example clause above states that the value of the Company which the Expert reaches should be divided by the number of shares in issue and then multiplied by the amount of the seller’s shares.
Clearly, there are other factors which an accountant will take into consideration – the above are only illustrations. Therefore, it is important to receive advice from accountants and solicitors when it comes to submitting an offer for a Company in such circumstances.
for further information please contact: scott kerr