Assessing the Value of Small Businesses: Understanding Minority Discounts in Operating Agreements and Owner Disputes

Description

Corporate counsel of small businesses should consider the effect disputes among the owners on the company's value that often is part of the resolution of these disputes. Recent cases have affirmed the contract principles that allow parties to set values and valuation methodologies for equity interests, whether shares in a closely held corporation, membership interests in a limited liability company, or partner interests in a general partnership. Courts favor the enforcement of agreements with buyback provisions. Knowing when and how marketability and minority discounts apply is a critical element of representing the closely held business in transactions or disputes.

Parties have wide flexibility in setting up buyback provisions and formulas for equity valuation. Parties should thoughtfully evaluate and clearly define the terms for buyback provisions used in operating agreements, buy-sell agreements, option agreements, and other contracts. The parties can use a market value concept that would allow applicable discounts to be considered, or statutory standards of value that may exclude such discounts. Case law supports parsing the valuation process even more discretely and allows agreements to use different values and discounts or premiums in different circumstances as the parties see fit.

Parties may want to revisit their valuation provisions currently in play. Even agreements that are decades old or that result in the under-valuation of the enterprise will likely be enforced as representative of the current intent of the parties. It is critical that the principals agree on a valuation that reflects the current owners' views of the value of the business. Most case law does not overrule statutory processes and other public policy considerations.

Listen as our authoritative panel discusses how and when shareholder activism and minority discounts impact an equity interest's value The panel will discuss best practices for reviewing and revising valuation provisions in current governance documents and buy-sell agreements. The panel will address the various valuation methodologies and how corporate documents should anticipate issues with potential discounts.