The Minority Discount in Contested Share Valuations

Should a discount be applied in the valuation of a minority shareholding in a private company?

Introduction

On the face of it, the answer to this question is a conditional yes.

However, much depends on the circumstances and the outcomes may be unexpected; in certain dispute-related situations, when a discount might be expected the opposite may apply and vice versa.

This article looks at a 2021 judgment by the High Court (Chancery Division) that sheds some light on an issue that may be significant and controversial, particularly in the valuation of a minority shareholding for buy-out purposes in a shareholders’ dispute.

Background

First some background, in outline.

In short, unless there is a requirement to proceed otherwise, ordinarily a valuation of a minority shareholding will be subject to a significant discount.

Under applicable UK company law, separately held equal voting- share shareholdings have different levels of control over the subject company. This may be by reference to the shareholding itself, or as a tactical holding with other shareholders.

Generally, although not a direct relationship because of how voting influence is arranged, the smaller the relative proportion held, the less relative control the particular holding has. Thus, although the shares may have equal voting rights, effectively, shares which are part of a very small holding may have no controlling influence. In contrast, shares which are part of a substantial holding may have full controlling influence.

As a result, for valuation purposes in terms of an open market sale, a shareholding that offers less control is treated as less attractive than one offering greater control. Therefore, ordinarily, in this context, the valuation of a minority shareholding is subject to a ‘minority discount’: this is principally to address any associated control limitations, and any assessed consequent adverse impact on its marketability.

In contrast, for valuation purposes under the terms of Articles of Association, or a Shareholders’ Agreement, a minority discount may not apply if only a simple proportional basis is required.

Contentious valuations

However, in the context of a dispute (“contentious valuations”) involving a minority shareholding, be it in a court litigation or arbitration process, subject to the significance of the applicable Articles of Association or Shareholders’ Agreement, the court may determine to apply, or not apply, a minority discount as a means of administering justice between the parties.

This is exemplified in the subject judgment [1] (see particularly paragraphs 107 to 109 thereof).

In outline:

• The case concerned a petition under Section 994 of the Companies Act 2006 for unfairly prejudicial conduct of the subject company’s affairs.
• The petition was brought by a shareholder and the sole director of the company as Petitioner (“the Petitioner”). This was principally against the former co-director who was also a shareholder (“the Respondent”).
• The order sought was, amongst other things, that the Respondent sell his shares to the Petitioner at a price to be determined, with a discount to reflect that the Respondent “…holds only a minority…” of the shares.
• There was also a cross petition.
• The subject shareholding amounted to 25% of the issued shares of the company.

In summary, the court concluded in the circumstances, amongst other things:

• The company was “…in the nature of a quasi-partnership from the outset…”.
• However, a minority discount should be applied notwithstanding the quasi-partnership determination. The extent of applicable discount was not dealt with as the proceedings concerned liability and not quantum.

In this regard, the following further extract from the judgment is noted:

…247.

As to whether a minority discount should be applied, the starting point is that, where the court is dealing with a quasi-partnership, it will not provide for a discount where an innocent vendor is a minority shareholder. I bear in mind however the last sentence of the passage of Nourse J’s judgment in Re Bird Precision Bellows Limited, which I repeat for convenience here:

‘Equally, if the order provided, as it did in In Re Jermyn Street Turkish Baths Ltd. [1970] 1 W.L.R. 1194, for the purchase of the shares of the delinquent majority, it would not merely not be fair, but most unfair, that they should receive a price which involved an element of premium.’

This is reflective of the position here. It is clear that [the subject Respondent] created a situation whereby he and [the Petitioner] could not continue in business together. The agreed solution is that [the Petitioner] should buy out [the Respondent’s] shares. I do not see why [the Petitioner] should be required to pay a premium for a buy-out to remedy a situation that he did not engineer, even though his reaction to it may itself be criticised. …”

Conclusion

Valuations of private company minority shareholdings will have their ‘ordinary’ complications. However, in contentious and potentially contentious valuations, subject to the significance of applicable Articles of Association and/or Shareholders’ Agreement, an additional layer of complication can emerge involving matters that may be considered relevant by a court or adjudicating tribunal. This may include the relationships between shareholders, the nature of the shareholding, and doing justice between the parties. In these circumstances a minority discount for a minority shareholding is not ‘a given’. Accordingly, professional valuations advice in this regard, through to the giving of expert witness evidence in court or arbitration proceedings, should be for those with suitable expertise and experience in this area.

[1] McMonagle v Harvey & Others [2021] EWHC 1374 (Ch)