How to Handle Valuation Disputes During Shareholder Buyouts
When business partners decide to part ways, the process can often become complicated. This is particularly true when it involves a shareholder buyout. Agreeing on the value of a business is a common point of contention. For business owners engaged in valuation disputes, securing legal guidance is the next logical step.
William B. Hanley, Attorney at Law, provides dedicated representation in business litigation to clients in Newport Beach, California. With over 40 years of experience, Attorney Hanley brings a no-nonsense approach to resolving disputes, with a track record that includes some of California's most significant legal victories. He is committed to helping his clients understand shareholder buyouts and explore ways to handle valuation disputes during these periods.
Understanding Shareholder Buyouts
A shareholder buyout occurs when one or more shareholders purchase the shares of another shareholder, effectively removing them from the company. This can happen for many reasons. A shareholder might wish to retire, exit the business to pursue other interests, or be forced out due to a dispute or breach of fiduciary duty.
While the concept seems simple, the execution can be filled with challenges. The buyout process is typically governed by a shareholder agreement, also known as a buy-sell agreement. This document outlines the terms and conditions under which a shareholder can sell their shares, including the events that trigger a buyout and, most importantly, the method for valuing those shares.
When this agreement is clear and well-drafted, the process can be relatively smooth. However, problems arise when the agreement is ambiguous, outdated, or non-existent. Without a clear roadmap for valuation, shareholders are left to negotiate a price, opening the door to significant disputes.
Common Causes of Valuation Disputes
Disagreements over a company's worth are at the heart of nearly all buyout conflicts. Several factors typically contribute to these disputes, each capable of turning a straightforward transaction into a protracted legal battle. Some of the more common causes of valuation disputes include the following.
Subjective Valuation Methods
There is no single way to determine a business's value. Different appraisers can use various methods, and each can produce a different result. Some common approaches include:
Asset-based valuation: This method calculates the net value of the company's assets minus its liabilities. It is often viewed as too simplistic, as it may not adequately account for intangible assets such as brand reputation or goodwill.
Market-based valuation: This approach compares the business to similar companies that have recently been sold or acquired. Its accuracy depends on the availability of comparable market data, which can be scarce for privately held companies.
Income-based valuation: This method focuses on the company's ability to generate future income. It involves projecting future cash flows and discounting them to their present value. Projections are inherently speculative and can be a significant source of disagreement.
Since each method has its own strengths and weaknesses, the departing and remaining shareholders often advocate for the approach that best serves their financial position.
Disagreements Over Intangible Assets
A company's value extends beyond its physical assets and cash reserves. Intangible assets like intellectual property, customer lists, brand recognition, and goodwill can represent a substantial portion of a business's worth. Valuing these assets is highly subjective. A departing shareholder who contributed significantly to building the company's brand will likely place a high value on goodwill, while the purchasing shareholders might try to minimize its importance to lower the buyout price.
Future Growth and Market Conditions
A company's potential for future growth is a key component of its value. Shareholders may have different opinions on the company's prospects. An optimistic departing shareholder might project high future earnings, leading to a higher valuation. Conversely, the remaining shareholders might point to potential market downturns or increased competition to argue for a more conservative, lower valuation. These differing outlooks are a frequent source of conflict.
Strategies to Resolve Valuation Disputes
When a valuation dispute arises, several paths forward are available. The goal is to reach a fair agreement without destroying the business or incurring excessive legal fees. Some strategies to consider when facing a shareholder dispute over valuation include the following.
Review the shareholder agreement: Always consult the shareholder agreement first. A well-constructed agreement should contain specific provisions for valuation, such as requiring a particular valuation method or specifying a process for hiring a neutral third-party appraiser.
Negotiation and mediation: Direct negotiation between the parties is the simplest and most cost-effective solution. If negotiations stall, bringing in a neutral mediator can help facilitate a resolution. A mediator does not impose a decision; instead, they help the parties find common ground and reach a mutually acceptable agreement.
Use multiple appraisers: A common strategy to break a deadlock is for each party to hire its own valuation professional. If the two appraisals are close, the parties might agree to take the average. If the values are significantly different, the two appraisers can be instructed to select a third, neutral appraiser whose valuation will be binding or used as a tiebreaker.
Legal action: If all other methods fail, litigation may be the only remaining option. Filing a lawsuit can be necessary to protect one's rights, especially in cases involving a breach of fiduciary duty or oppressive conduct by majority shareholders. A court can compel a buyout and determine a fair price, often with the help of court-appointed appraisers as outlined in the California Corporations Code.
California Laws Governing Shareholder Disputes
In California, shareholder rights and corporate governance are primarily defined by the California Corporations Code. When valuation disputes arise during a buyout, several sections of this code become relevant.
One key provision is California Corporations Code § 2000. This statute provides a legal mechanism for a corporation or its remaining shareholders to buy out the shares of a shareholder who initiates a voluntary dissolution of the company. Under this section, the court can appoint three independent appraisers to determine the "fair value" of the shares.
"Fair value" is defined as the liquidation value as of the date the dissolution action was initiated. However, it takes into account the possibility that the business may be sold as a going concern. This prevents the purchasing shareholders from artificially depressing the value. The appraisers' valuation is then submitted to the court, which makes a final determination. While this process provides a structured path, it can still be contentious, as parties may dispute the appraisers' findings.
Furthermore, issues of fiduciary duty often intersect with valuation disputes. Majority shareholders owe a fiduciary duty to minority shareholders, meaning they must act in the best interests of the corporation and all its shareholders.
If a majority shareholder attempts to use their power to force a buyout at an unfairly low price, they may be found in breach of this duty. This can lead to litigation where the court may not only adjust the valuation but also award damages.
Business Litigation Attorney Serving Irvine and Newport Beach, California
The determination to help those who have been wronged is the foundation of Attorney William B. Hanley’s career as a litigator. As one of California's top civil trial attorneys, Attorney Hanley has over 40 years of experience and a record that includes a landmark $50 million verdict and one of the largest punitive damage awards recorded.
He takes a direct approach to client representation, emphasizing open, honest communication on all significant case decisions. The law firm of William B. Hanley, Attorney at Law, serves California residents in Irvine and Newport Beach, Orange County, Los Angeles County, and San Diego County. Reach out today to explore how you can resolve valuation disputes in shareholder disputes and other business litigation matters.