Tips for Disputes Involving the Valuation of a Closely-Held Company
By: JAMES E. DORSEY & EMILY E. DUKE
If you are in a dispute over the valuation of a closely held company, here are two tips that we have learned over the years that have helped us get good valuation decisions from judges at trial:
Hire an appraiser who is an expert in the specific industry. While there are lots of generalist business appraisers out there, getting an appraiser who knows the industry, its jargon, its quirks, its way of doing business, can make all the difference. Several years ago, we were involved in a dispute over the value of several car dealerships. We had found an appraiser who did nothing but provide consulting and valuation services to car dealerships. The other side had a well known generalist appraiser. in addition, the judge, exercising his prerogative under the statute, had hired his own appraiser -- another generalist.
The other side’s generalist appraiser came up with a value of X; our specialist car dealership appraiser came up with a value of 3X; and the court’s generalist appraiser came up with a value of just under 2X. Going into trial, smart money would have bet on the judge’s coming up with a value of around 2X. During the testimony of the court’s generalist appraiser, however, our specialist appraiser wrote us a note that we should ask that witness about a particular line item on his financial spread sheet. The line item was peculiar to the car industry and was actually a cash equivalent. It was clear from the court’s expert’s spread sheet that he had not treated it as such. So on cross examination we asked about that and revealed that the court’s expert did not, in fact, know what that line item was. In the judge’s memorandum order in which the judge described how he had come up with a value of 3X, the judge noted that same cross examination testimony in explaining why he had not given his own expert’s testimony any credence.
We had actually learned this lesson the hard way a few years before. In that earlier case, the other side had an industry expert appraiser and we had engaged a generalist appraiser. The case involved a business in what was the then-new telecommunications technology. While we prevailed on knocking out some highly dilutive stock options, the court’s valuation was much closer to that of the other side’s appraiser than to our appraiser’s valuation. We attributed that part of the decision to our failure to have persuaded the court that our appraiser knew as much about the industry as the other side’s appraiser.
If you represent an owner of a closely held company in a valuation dispute, always find out which lender the company uses and get the lender’s loan files (via subpoena or through your client). In those files, you will find out what the company has been telling its lender. Companies are apt to give their bankers very optimistic market projections and sales forecasts. You will also get the loan officer’s candid assessment of the company, its management, and its prospects. Bankers’ loan files and notes can be a gold mine or a disaster, depending on your client’s expectations. In our experience, we have frequently found a disconnect between what management tells its minority shareholders and what it tells its bankers. This can be particularly true in a squeeze-out situation where management may be seeking a loan to fund its buy-out of the minority. It may not be pretty, but it’s human nature. And it happens. Make sure that you investigate whether it has happened in your case.