Shareholder Issues Arise When Full Enterprise Value Fails to Be Assessed
In dissenters' rights actions, shareholder oppression and member disputes as well as in breach of fiduciary duty cases, the fair value of a company becomes center stage for debate. As shareholders and companies keep an eye out for their livelihood, court proceedings oftentimes lead to discussions of a forced buyout to resolve the dispute. A business' appraised value becomes the remedy to determine what amount each person deserves due to his or her role in the business. As the court decides on a value, the most frequent standard of value applied is a fair value analysis.
Fair Value Issues Emerge Depending on the Type of Analysis Used
To arrive at a fair value, the court generally will have the parties present evidence of the business' value. This evidence is usually in the form of reports and testimony from valuation experts regarding their analysis or conclusions of a business' value. These indications of value will begin with a value for the entire enterprise and then move to the value of the particular equity interest in it. When valuing the enterprise, the view is that it should represent the entire equity or a "control level" of value. From the control level value, the value of the particular interest can then be derived.
In arriving at the indications of value for an enterprise as a whole, experts rely on publicly available or observable data that is most often derived from public, traded company share information. However, since the subject interest being valued in most shareholder disputes is not publicly traded, public or observable data has to be analyzed for its relevance and usefulness.
The application of public company data regarding the privately held company interests presents a number of significant "translation" issues. In particular, to the extent that a shareholder's interest is based on a per share or comparable public companies basis, the value will reflect a minority position that lacks the prerogatives of ownership control. In the determination of fair value, most state statutes and courts will not allow a discount for lack of control. If the public data reflects a minority position, then the question arises as to whether the valuations based on it already contain a discount for lack of control.
Control Premium Considerations
To adjust for this potentially inherent discount, valuation experts will determine a tentative indication of value and then consider applying a "control premium" to it. The consideration of a control premium is seen as necessary to reach the control level of value or, in other words, will eliminate any discount for lack of control in the tentative indication of value.
A variety of responses by courts regarding this consideration of a premium exists, including the decision to:
- apply the control premium because the base data came from minority interests using the guideline public company method
- disallow the merged and acquired companies method since it includes synergies that are not reflective of the control value of the company on a stand-alone basis
- allow or require the adjustment or disallow it on a regular basis
- leave the issue to be a matter of fact to be determined on a case-by-case basis
- consider the market approach to value but eliminate the income approach to value
Market Approach Values Scrutinized for Supportable Conclusions
The market approach to valuation involves the use of data from public companies found to be "comparable" to the private company. The techniques include the: guideline public company method involving stock quotes for an individual share; guideline merged and acquired company method that analyzes completed transactions for an entire company; and, past publicly announced transactions that may have involved a minority interest.
The guideline public company method yields information on a minority share basis, which then presents the issue of the application of a "control premium." The guideline merged and acquired method, in contrast, represents a control level value without the need for an adjustment.
Until recently, experts generally would look to the traded share price of a company before and after the announcement of a merger or sale to obtain data to estimate the impact of the control premium. This practice was used because many experts thought that it represented the value that the acquirer ascribes to all of the shares and the prerogative of control that comes with it. However, this seemingly straightforward approach has come under increased scrutiny in recent years. In April 2013, the Appraisal Foundation released a discussion draft titled "The Measurement and Application of Market Participant Acquisition Premiums" that addressed the "control premium" and what it deemed as the best practices in applying this type of premium.
Market Participant Acquisition Premium Terminology Introduced for Financial Reporting
The Appraisal Foundation's discussion draft was intended as guidance on best practices for preparing fair value measurements in financial reporting and was not intended for any other valuation purpose. Rather than use the term "control premium," the draft introduces a new term "market participant acquisition premium" or MPAP. The purpose of the new term is to (1) emphasize the market participant perspective of the value of the prerogatives of control and (2) "distinguish this premium from the more general, and occasionally controversial, notion of the control premium."
This generalized notion of a control premium and the means of determining it have been criticized for including elements of synergistic value that are attributable to the buyer and not the enterprise. In addition, some have concluded that the guideline company transaction indications of value have, at least conceptually, been too high as some experts have shown that data from premiums for control and values from going private transaction are better indicators overall. Others have argued that in an efficient marketplace, the per share market price of a well-managed public company already reflects most if not all of the value of control. As a result, the application of a control premium to valuations in appraisal actions based on fair value has also become the subject of debate.
While the Appraisal Foundation's discussion draft expressly states that it was intended for financial reporting purposes only, it does offer a number of useful discussions on best practices in ascertaining the value of the prerogatives of control. By raising the question of the value of "control," it triggers a discussion of (1) the extent of the MPAP in fair value appraisal actions along with (2) the analysis required to demonstrate what impact opinions submitted in connection with appraisal actions may have.
Because the premium adjustment is fact-sensitive and determined under the approach of the particular court, few generalizations exist. As with other aspects of fair value, fairness will be in the eyes of the beholder in the relevant jurisdiction. For numerous industries that focus on assessing market values of a business, the discussion of the MPAP approach is increasing. The need for reliable valuation measurements and experienced shareholder counsel to forecast how these valuation methods can make an impact is paramount.