The value of a shareholder dispute

Many of us experience disputes almost every week, whether at home or at work or at any other place and time. People often solve their disputes alone without the help of others assisting them. However, when there is a lot of money at stake, there is usually a need for an independent opinion from a third party to help resolve the issue. This is often the case in disputes between business partners or shareholders, and one of the key concerns in that situation is the value of the entire business and of the individual shareholdings. 

Shareholder disputes exist due to many different reasons and can arise regardless of whether the individual or company is a minority or a majority shareholder. Minority shareholders may believe that their rights have been violated, that they have been excluded from meetings, they may disagree with the company’s strategy and decisions made by majority shareholders, or they may not be satisfied with the performance of the company. A majority shareholder, on the other hand, may have issues with a minority shareholder’s separate business interests, their demands on the company in question or that they are circumventing the company’s operations. 

Over the last 12 months we have been approached by number of Cayman business owners, or lawyers representing the shareholders, to assist them in forming an opinion on the value of the company and their stake in it. A common reason is that the minority shareholders are not satisfied with the company’s recent performance and, as a result, with their dividends. The other side usually does not have the same view as to why this is the case – whether it is due to the overall market depression, an excessive cost base, management incompetence or unreasonable expectations. Whatever the reason, however, non-controlling shareholders do not want to have their investment/cash tied up in a ‘low-performing’ company and may consider exiting from the business.  

The results of a shareholder dispute will differ on a case-by-case basis. One can end with a buyout of the non-controlling stake by the majority shareholder, another one can lead to a sale of the business to a third party, or may end with an agreement to wind up the company. Before any of these events can eventually happen, the shareholders need to understand what the value of their business is, and this is when an independent third party adviser may be of help. But what if there are two or more independent advisers who arrive at different opinions on the value of the business? How can this actually happen? Is there no objective value, irrespectively of who conducts the valuation? Unfortunately, no valuation can be completely objective. There exist, of course, International Valuation Standards and professional valuation qualifications with an aim to create a best-practice approach and standardise the methodologies; however, a valuation will always require professional judgment to some extent, which makes it a little subjective. 

A number of methodologies can be used in a business valuation and the appraiser has to select the most appropriate one depending on the situation. Most frequently, the value of a business will be determined by so called Discounted Cash Flow methodology in which the value is estimated based on the company’s forecast cash flows that are discounted to their present value using the weighted average costs of capital of the company. Another factor that needs to be considered is the standard of value to be used as a basis for valuation. There are many standards such as a net book value, liquidation value, or investment value, but when determining value in a shareholder dispute, an appraiser will probably use either a fair market value, or fair value.  

The main difference between the two is that the fair market value takes into account discounts or premiums for management control or marketability of shares, while the fair value does not. Therefore, valuation of a minority stake based on a Fair Value principle may end up much higher than one based on a Fair Market Value. Each shareholder dispute is different and in many situations it is difficult to decide which of the two is more appropriate. Furthermore, the appropriateness usually also depends on the particular jurisdiction and its legal system.  

There are number of questions that any valuation expert needs to answer to correctly determine the value of a company, such as: “How is the company positioned on the market?”, “What are the company’s future revenue prospects?”, “What capital investments does it have to make and how will these be financed?”, or “What is the riskiness of achieving the forecasted cash flows?” When speaking about Cayman there are also other relevant questions that need to be answered given the small size and industry focus of the local economy: “Is there any growth potential at all?”, “Are there any potential buyers who might be interested?”, or “Will the tax/business fees and regulatory regime remain unchanged in the future?” 

We have witnessed a number of situations in which the value of a local company was based on its comparison with large international players operating in the same industry, although the businesses were practically incomparable. In other cases, companies forecasted aggressive sales growth despite a decreasing trend in sales and without any supporting evidence this would change. Sometimes, appraisers were using a cost of capital that did not take into account increased uncertainty and higher financing costs in the Cayman economy.  

So how can shareholders be sure a valuation report they have paid for will be accepted by the counter party and/or the court? They cannot. Although the appraisers need to be unbiased and prepare a valuation that is as fair as possible, most of the time different appraisers will arrive at different results when valuing the same company. Hence, it is essential for the appraisers to have a thorough understanding of the business being valued, its industry, the local and global economy and enough experience and credible arguments to support the assumptions and results of the business valuation. Otherwise, it will be challenged by the counter party and will often serve to only slow down the process of reaching a solution to the shareholder dispute.