Resolving Minority Shareholder Disputes Through Valuation

What makes you a minority shareholder? If you hold less than 50% of shares in a company, you are a minority shareholder. You will also have limited rights in voting, controlling, and decision-making processes. Given the limitations, there might be a situation where things might end up in disputes.

A business valuation will be the right choice for resolving shareholder disputes fairly. Unlike established companies, where minority shareholders might be diluted, in SMBs, each shareholder’s stake carries more weightage.

So, arriving at a solution that benefits each stakeholder during shareholder disputes is important for the company’s growth. It is all about everyone getting a fair slice. The article below focuses on the role of valuation in minority shareholder dispute resolution and the best practices to follow during the process.

Minority shareholder dispute and business valuation

Business valuation plays a huge role in resolving minority shareholder disputes. Business valuators use different approaches to calculate the “fair value” of SMB stocks. The fair value helps determine how much the buyer should pay for the minority stock in cases of buyout or to give them a fair compensation.

Minority shareholder disputes are possible because of their limited rights and degrees of influence in the company’s operations. The organization must move swiftly to resolve any issues and keep business as usual. Also, majority owners should be aware of the legal protections afforded to minority shareholders to avoid potential conflicts.

Common causes of minority shareholder disputes

The feeling of being ignored or dominated by the majority shareholders is the most common reason for minority shareholder disputes.

• Disagreement on the company’s direction – While minority shareholders believe that the company does not consider their viewpoints while making important business decisions, this can lead to minority shareholder disputes.
• Dividend withholding – Minority shareholder disputes can occur if they feel their dividends are on hold without reasonable justification. This shows that minority shareholders are discriminated against and can take legal action.
• Share Dilution – When majority shareholders set a high subscription price, it may not be affordable for minority shareholders. Because of this, they cannot subscribe to shares under any new share issue, resulting in minority shareholder disputes.
• Shareholder Rights and Voting Power – Conflict can arise when there are disputes in voting rights ,dilution of shares or shareholders are treated unfairly, such as a differential in access to information or decision-making procedures.

Role of valuation in minority shareholder dispute resolution

Before a minority shareholder dispute turns into litigation, having an independent third party evaluate the company is in everyone’s best interests. An independent business appraisal can help resolve issues with minority owners in many ways:

Business valuation methods such as Income Approach, Market Approach and Asset-based approach, all these methods depend on real facts and evidence of the business to help get an objective financial assessment.

As the business valuation experts consider factors like revenue, earnings, market comparables and assets. It helps to get a realistic estimate of the business. The main role of valuation in minority shareholder dispute resolution is to ensure fair compensation for minorities. Business valuation experts examine the company’s performance to ensure fair compensation against the shareholders’ investment.

Methods for Valuation in Minority Shareholder Disputes

There are various approaches to conducting a business valuation in minority shareholder disputes. They are as follows:

Income Approach

The income approach assesses businesses based on the present value of their future earnings or cash flows. To calculate these cash flows or future earnings, the evaluator must first predict the company’s profits and then modify them to account for changes .

The income approach has two main methods. They are: Capitalization of Earnings Method and Discounted Cash Flow (DCF) Analysis:

Case study for Valuation of Minority Shareholder Dispute with Income Approach

Brown Corporation, a growing tech company, faces a valuation dispute between its shareholders during a potential buyout by the majority shareholders. The minority shareholders believe they are being undervalued. To resolve this dispute, the valuation of Daze Corporation is conducted using the Discounted Cash Flow Method of the Income approach.

Forecast Cash Flows: Project future cash flows. Here’s a sample for the next five years:

• Year 1 – $1,000,000
• Year 2 – $1,200.000
• Year 3 – $1,400,000
• Year 4 – $1,500,000
• Year 5 – $1,600,000

Discount Cash Flows: Discount each year’s cash flow to present value using the 10% discount rate. The present value (PV) of each cash flow can be calculated using the formula:

• PV = Cash Flow / (1 + discount rate)^number of years

The present values of cash flows are:

• Year 1 – $ 909,091
• Year 2 – $ 991,736
• Year 3 – $ 1,051,841
• Year 4 – $ 1,024,520
• Year 5 – $ 993,474

Terminal Value: Assume a 3% perpetual growth rate after year 5. The terminal value is approximately $ 23,542,857.

Enterprise Value: Sum the present values of all cash flows and the terminal value. This gives us the company’s valuation of $ 28,513,519.

Valuation for Minority Shareholders

Assume the company has 1,000,000 shares outstanding, and the minority owns 100,000 shares. The per-share value would be:

• Per-share value = EV / Total shares outstanding = $ 28.25
• Approximate Value of minority shares = 100,000 × 28.25 = $ 2,825,000

This DCF analysis provides a basis for resolving the dispute by offering a well-founded valuation of the minority shareholder’s stake in the company.

Market Approach

The market approach determines a company’s worth by examining how similar businesses perform. The comparable situations can be:
A previous transaction involving the same business Transfer of ownership in a similar company (public or private market quote of listed shares of a similar public company.

Case study for Valuation of Minority Shareholder Dispute with Market Approach

Let’s consider another company, Daze Corporation. To resolve the dispute, Daze Corporation’s valuation is conducted using the market approach.

• Identify Comparable Companies:
  • Daze Corporation is compared with three similar tech companies (A, B, and C) that were recently sold.
  • Company A – Sold for $50 million with annual revenues of $10 million.
  • Company B – Sold for $75 million with annual revenues of $15 million.
  • Company C – Sold for $100 million with annual revenues of $20 million.
• Calculate Valuation Multiples:
  • A – $50 million / $10 million = 5x revenue
  • B – $75 million / $15 million = 5x revenue
  • C – $100 million / $20 million = 5x revenue
  • Average revenue multiple – (5 + 5 + 5) / 3 = 5x
• Apply the Multiple to Daze Corporation:
  • Daze Corporation has annual revenues of $12 million.
  • Estimated value of Daze Corporation: $12 million * 5 = $60 million
• Determine Minority Shareholders’ Value:
  • The minority shareholders own 20% of Daze Corporation.
  • Minority shareholders’ share value: 20% * $60 million = $12 million

Using the market approach, the value of the minority shareholders’ stake in Daze Corporation is estimated to be $12 million. This valuation provides a basis for the majority shareholders to offer a fair buyout price, thereby helping to resolve the dispute.

Asset-Based Approach

The asset-based approach looks at the total value of your company’s assets. These include tangible assets like real estate and cars and intangible assets like intellectual property, such as rights and trademarks.

There are two methods to this approach. Asset Accumulation Valuation and Excess Earning Valuation

Case study for Valuation of Minority Shareholder Dispute with Asset Approach

Let’s use the Asset Approach to resolve this minority shareholder dispute in BrightTech Solutions:

• Assets:
  • Current Assets – $6.5 million (Cash: $2M, Accounts Receivable: $1.5M, Inventory: $3M)
  • Fixed Assets – $8 million (Property, Plant, and Equipment)
  • Intangible Assets – $4 million (Patents and Trademarks)
    Total Assets: $18.5 million
• Liabilities:
  • Current Liabilities – $3 million (Accounts Payable: $1M, Short-term Debt: $2M)
  • Long-term Liabilities – $4 million
  • Total Liabilities – $7 million
• Net Asset Value (NAV): $18.5 million – $7 million = $11.5 million
  • Minority shareholders own 25% of BrightTech Solutions
  • Minority share value: 25% * $11.5 million = $2.875 million

Based on the asset approach, the value of the minority shareholders’ stake in BrightTech Solutions is estimated to be $2.875 million, establishing a fair basis for resolving the dispute.

Best practices for fair value assessment in minority shareholder dispute

Below are the few best practices suggested by experts for the fair value assessment in minority shareholder dispute,

• Consider Including a Calculation in the Contract – Mentioning the predetermined calculation method is better. For example, the contract should specify the methods for calculating fair value.
• Include an Expert Determination Clause – What is an expert determination clause? It is a process where all the parties involved agree that an independent and impartial business valuation expert is needed to make a decision.
• Consider the Wording of the Articles of Association – We know there can be various reasons for minority shareholder disputes. If you experience any issues as a minority shareholder, it is important to check the extent of your rights.
• Assess the Value of Pending Derivative Claims – A derivative claim against a company’s director for their actions or inactions is a derivative claim. Third persons engaged in the same wrongdoing as the directors can potentially be the targets of such a claim. Consider any pending derivative claims to guarantee fair value assessment in conflicts involving minority shareholders.
• Avoid Lack of Control Discounts – Lack of control discounts refer to the decrease in the value of an ownership interest in a business caused by the owner’s incapacity to control the company’s operations and decision-making. It is important to consider these discounts to assess the minority ownership interest in the business fairly.
• Use Independent Appraisers – Hire an independent appraiser to cover all these best practices and ensure a credible valuation process. With their knowledge and experience in the business valuation process, the experts can help in resolving minority shareholder disputes through valuation.

How professionals help to resolve disputes among minority shareholders

As various methodologies and nuances exist, seeking support from professional valuation experts is better. Here’s how they can help:

• The valuation experts will have years of experience and knowledge in various business valuation processes. This can help you get an accurate valuation report. At Eqvista, we have NACVA-certified valuation experts who will make your job easier by conducting a precise business valuation.
• The main reason for having an independent valuation in a minority shareholder dispute is to have an unbiased valuation. At Eqvista, we provide impartial business valuation to help mitigate risks between the minority and majority shareholders.
• As we know, there are various valuation methodologies used to conduct a business valuation. Eqvista’s professional team is well-versed in all these approaches and, with in-depth knowledge of accounting concepts, can help in resolving minority shareholder disputes through valuation.
• Additionally, business valuation through professionals in Eqvista gives you credibility in valuation. This, in turn, helps comply with the legal requirements in cases of minority shareholder disputes.

How Eqvista can help you Resolving Minority Shareholder Disputes through Valuation

Minority shareholder disputes often require a business valuation to determine fair compensation for the minorities’ investment. To ensure an accurate valuation of your company, seek support from professional valuation experts.

With a team of skilled valuation experts, Eqvista can help you get your company valued precisely. Our professionals support providing an impartial and in-depth company valuation considering all the business nuances.

You also get an added advantage over valuation credibility, as our experts have the right credentials to conduct a business valuation. To learn more about how we can help your company in minority shareholder disputes, contact us Today!