In a recent case, a Wisconsin family owned business wanted to exercise its option to buy back the shares held by the son of the majority owner, his father. A poorly written business valuation report combined with an ambiguously written shareholder agreement resulted in lengthy and contentious litigation between the son and the company over the value assigned to the son’s shares.
There’s never a guarantee of a smooth buyout of a minority shareholder. I see this in practice all the time. Quite often the shareholder agreement includes a buy-sell provision or option. In such an agreement, the shareholder is usually bought out according to a formula or based upon a business appraisal. If the latter, the business valuator hired by the business will decide the amount or the shareholder will get his own appraisal from a business valuator he chooses. Sometimes a third appraisal is needed as well.
An Overview of Swiderski Equipment v. Swiderski, 2017
Swiderski Equipment dealt in farm equipment and technology. The father, Alex, owned the majority interest, while his son James started out working for the company and eventually became the only minority shareholder. Both parties agreed to a corporate redemption agreement (CRA) that allowed the company to repurchase the son’s shares. The agreement stated a price but also permitted reappraisal in some situations.
James decided to leave the company in September 2008. The company exercised its option to repurchase the son’s shares at the price stated in the CRA, which had been determined as $1,000 at the time the CRA had been executed. James and his wife Sandra were at the same time involved in a contentious divorce. Sandra contested the redemption. Alex and the company then filed a lawsuit to enforce the CRA. By July 2009 things had changed. Now James and Sandra wanted to go ahead with the buyout at the $1,000 per share value. Citing the “drastic downturn in the economy,” the company stated it no longer wanted to buy out the minority shares at that time.
The case went back and forth between the parties over the next few years, disagreeing on the value of the shares and whether or not the company was obligated to repurchase the shares when James and Sandra wanted then bought back. In January 2013, Swiderski Equipment paid James $510,000 for his 510 shares. James accepted that the company had the right to repurchase, but he disagreed on the value of the shares.
Finally in June 2015 a circuit court ordered revaluation of the stock, to be performed by Mark Hanson, who worked for Swiderski Equipment’s accounting firm. Hanson estimated James’s stock was worth $615,000 as of December 31, 2012. The court ordered the company to pay James $105,000, the difference between the amount already paid and the new valuation. James challenged the valuation again, arguing that the value should be based on current value of the company, not what it was worth at the end of 2012. The court ordered another revaluation in which the appraiser would value the entire corporation, not just the value of shares held by James. The appraiser would not be able to apply a minority discount but would be permitted to determine whether a marketability discount applied.
Business Valuation Reports Need Clarity
Every business owner that has a shareholder agreement or has an agreement on how shareholders will be paid on exit needs to take care in writing the agreement. You need to precisely state the amount of discount for lack of control and the discount for lack of marketability, if applicable. Otherwise, in nearly every state in the union you have a Fair Value Statute that applies. Generally, you cannot take advantage of a minority shareholder if the minority shareholder claims he is oppressed. Typically, minority interests are not worth their percentage ownership of the whole. Discounts may be applicable and they need to be spelled out in the shareholder agreement if they are to be used for stock redemption.
For clarity when writing a shareholder agreement, it helps to have professional assistance from an accredited business valuator, such as the staff at TD&T.