What Is Fair Value for a Minority Shareholder?
Unless a private limited company has a sole owner or is owned by a holding company, it will almost always have majority and minority shareholders (members) and at least one director.
Limited companies can have equal shareholders — such as in a 50/50 ‘partnership’ arrangement — but where legal advice is obtained, this type of structure is generally discouraged because it can lead to deadlocked companies if there is a disagreement between joint owners.
Individuals often form a company with the best of shared intentions.
However, if the interests of equal shareholders diverge over time or circumstances change, it can severely hamper decision-making and the continued viability of the business.
There can often be a slow development of frustration that contributions of time, money or towards the success of the business are not equal, which is fertile ground for disputes and litigation.
As the name suggests, a majority shareholder owns the lion’s share of a company and has the final say in many business decisions.
A company director can be a majority or minority shareholder — but it is not a requirement.
A director is a company officer with specific operational duties to the business and to the company itself.
Company directors are often employees or contractors with no ownership stake in the business.
A company director’s role is analogous to a ship’s captain. — A director is responsible for steering the business and day-to-day decision-making but is not always an owner of the ship (or company).
In smaller companies, it’s common practice for owners or majority shareholders also to be directors in an owner-managed enterprise.
It’s also common that circumstances are encountered where a party will be offered minority shares in a private limited company for numerous reasons, including:
- Selling a stake in the business
- Raising capital
- Incentivising directors or valuable employees to
- Join the company
- Improve performance
- Stay
A shareholders agreement (if any) and Articles of Association will set out a detailed process to follow if a minority shareholder elects to sell their shares and will also cover other situations.
Within many shareholder agreements, a minority shareholder will have given the majority shareholder(s) the first option to acquire the shares at ‘fair value’.
However, unless the method for calculating fair value is explicitly laid out in the agreement, the Court’s definition of what constitutes ‘fair value’ of a minority shareholding in a company will be far from clear — and up for grabs.
A Case Example: Re Euro Accessories Ltd
The judgement in Euro Accessories Ltd [2021] EWHC 47 (Ch) sheds some light on how the High Court interprets the ‘fair value’ of a minority shareholder’s stake in a forced buyout when no method for calculating the value was agreed on, and the shares’ value is in dispute.
What Happened?
What follows is a timeline of events leading up to the litigation and case of Euro Accessories Ltd [2021] EWHC 47 (Ch)m, as well as key takeaways from the judgment for majority and minority shareholders.
2000 — Euro Accessories Registered as a Private Limited Company
Euro Accessories Ltd. — a business specialising in concrete construction supplies — is registered as a private limited company by Mr Gilsenan.
Mr Gilsenan was the sole shareholder.
2003 — Mr Monaghan Is Hired as an Employee
Mr Monaghan joins Euro Accessories as a sales representative.
2008 — Share Transfer
Mr Gilsenan transfers 24.99% of his shares in Euro Accessories to Mr Monaghan and retains 75.01% of the company shares.
January 2010 — Mr Monaghan Resigns
The relationship between Mr Gilsenan and Mr Monaghan deteriorates to the point where Mr Monaghan tenders his formal resignation.
2010 — 2016 Share Price Negotiations
Once Mr Monaghan left the company, Mr Gilsenan sought to purchase Mr Monaghan’s 24.99% minority stake back from him.
However, no mechanism for determining the shares’ value existed in a binding agreement between the two parties. There was no shareholders agreement.
Mr Monaghan and Mr Gilsenan could not reach an agreement on the buyback price.
March 2016 — As Majority Shareholder, Mr Gilsenan Passes Special Resolutions
Having reached an impasse in negotiations over the purchase price for Mr Monaghan’s shares, Mr Gilsenan proposed several special resolutions.
- Mr Gilsenan’s shares would be converted to “A” class shares. Mr Monaghan’s shares would be converted to “B” class.
- The articles of association should be amended to give a holder of A shares the right — with written notice — to force the holder of B shares to sell them to the A shareholder at “fair value.”
As Mr Gilsenan was the majority shareholder, owning 75.01% of the shares issued, he was entitled to pass the resolutions without consulting Mr Monaghan or seeking his consent.
April 2016 — Mr Gilsenan Serves Mr Monaghan Written Notice
Under the amended articles of association that he himself approved, Mr Gilsenan sent Mr Monaghan written notice requiring him to sell his 24.99% minority shareholding back to Mr Gilsenan for a total price of £175,000.
Mr Monaghan refused to transfer his shares and did not cash the cheque for £175,000 that Mr Gilsenan tendered or any further cheques that were sent.
Ultimately, Mr Gilsenan exercised a right he’d granted himself in the amended articles to force the transfer of shares.
January 2019 — Mr Monaghan Petitions the High Court
Unsatisfied with Mr Gilsenan’s valuation of his minority shareholding in the forced buyout, Mr Monahan petitioned the high court.
At issue was not Mr Gilsenan’s prerogative to force a buyout of Mr Monahan’s shares. Rather, it was primarily a dispute over the price to be paid and the value of the shareholding.
Mr Monaghan argued that the £175,000 Mr Gilsenan undervalued his shareholding and that he’d been treated with ‘unfair prejudice’.
Mr Monaghan petitioned the Court under section 994 of the Companies Act to compel Mr Gilsenan to pay 24.99% of the total issued share value of the company — also known as the ‘pro rata’ value.
Based on the valuation of the jointly instructed expert in the case, Euro Accessories Ltd was worth £2.18 million at the agreed date of transfer in 2016.
If the Court had agreed with Mr Monaghan, the value of his shares should have been set at £545,000 — more than triple the £175,000 he tried to pay in the forced buyout attempt.
It is common practice for minority shareholdings to be valued at a discount to their pro rata value.
In this case, the valuation expert considered that a 55% discount should apply to Mr Monaghan’s shareholding, bringing the purchase price up from the £175,000 Mr Gilsenan offered in consideration to £245,000.
Mr Monaghan argued that the discount against the shares’ pro rata value was “unfair” and should not apply for the following reasons:
- It is common practice that a discount be applied against the pro rata value of a minority shareholding when the sale takes place between “willing parties.” Mr Monaghan was unwilling to take Mr Gilsenan’s original offer of £175,000. Further, Mr Monaghan argued that “no reasonable businessperson” would accept “an unrestricted right in the majority to expropriate the shares of the minority at will” conferred in the amended articles of association.
- The IVSC definition of ‘fair value’ should apply. According to the 2013 edition of the International Valuation Standards, fair value is “the estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties”. Using this definition, Mr Monaghan argued that the valuation should be the median between the pro rata share price and the discounted share price, so £395,000.
- ‘Fair value’ should be “just and equitable”. Mr Monaghan alleged that because he and Mr Gilsenan entered into an arrangement of mutual trust, it was unfairly prejudicial for his shares to be expropriated at a discounted value.
Mr Gilsenan’s solicitor sought to have Mr Monaghan’s petition dismissed on numerous grounds and the High Court ultimately rendered its decision.
January 2021 — The High Court’s Decision
On January 13, 2021, Mr Justice Snowden dismissed Mr Monaghan’s petition.
In his Points of Defence, Mr Gilsenan had offered to accept and pay the jointly instructed expert’s ‘fair value’ price of £245,000 for Mr Monaghan’s 24.99% shareholding — the pro rata company value less the 55% minority discount.
Justice Snowden upheld the expert’s valuation and declined to make any order of payment, as Mr Gilsenan had already agreed to pay Mr Monaghan the £245,000 plus interest.
Key Takeaways for Majority and Minority Shareholders
Pending further legislation or precedent, the decision in Re Euro Accessories Ltd will continue to significantly impact the commercial relationship between majority and minority shareholders — especially if a dispute arises.
Here are the essential points to consider.
Minority Discounts Are Assumed in “Fair Value” Transactions Between Shareholders
The percentage amount of a minority discount may vary in a dispute over ‘fair value’ between shareholders for numerous reasons, including:
- Particulars of the case
- Valuation method
- Expert opinion of a valuation professional
- The Court’s discretion
However, regardless of unique circumstances, it’s unlikely the Court will find in favour of pro rata pricing for a minority shareholder in a dispute.
Interpretation of ‘Fair Value’ and the Articles of Association
Further to the point above, Mr Justice Snowden noted that the interpretation of provisions in a company’s article of association:
- Must concentrate on the natural and ordinary meaning of the words used
- [Be] “viewed in light [of] extrinsic facts about the company or its membership that would reasonably be ascertainable by any reader of the company’s constitution and public filings at Companies House, and commercial common sense.”
Based solely on the articles of association and company filings, an independent third party would have no means of evaluating Mr Monaghan’s claims of unfair prejudice.
Even if the call option did constitute unfair prejudice, precedents for upholding a minority discount exist.
Specify a Mechanism for Share Valuation
The best way to avoid disputes over the value or ‘fair value’ of shares is to include a concise mechanism for determining it in a shareholders agreement or, alternatively, the articles of association.
Leaving the meaning of ‘fair value’ open to interpretation creates risk and uncertainty for all parties.
Need Advice? Contact Helix Law.
Hindsight is a wonderful thing. If you’re a shareholder owner or majority shareholder in an established company, understanding your position, factoring in what is achievable, and where your risks and opportunities lie early is fundamentally important.
If you’re a shareholder involved in a dispute, obtaining expert legal advice as soon as possible is essential.
The commercial team at Helix Law has decades of experience litigating shareholder disputes and unfair prejudice petitions. We understand the commercial world and the importance of understanding and positioning you for a positive and successful outcome if you are involved in a shareholder dispute.
Depending on the unique circumstances of your situation, we are happy to consider various funding options with you.
Contact Helix Law today. We aim to respond to all queries within an hour.
Frequently Asked Questions
What Is Shareholder Fair Value?
Fair value is a frequently used term in the Shareholder Agreements and Articles of Association of private limited companies. It often refers to how a minority shareholding should be valued in the event of a compulsory or voluntary buyout by other company members (shareholders). Without a specific mechanism to determine fair value, the Court will likely apply a minority discount to the pro rata value of minority shareholdings.
What Is the Threshold for Minority Shareholders?
Under the Companies Act 1996, minority shareholders have limited rights. The larger the shareholding, the more influence the shareholder can have over company affairs. There are numerous tiers with different rights granted to minority members by the percentage of total shares issued, including 5%, 10%, 15%, and 25%. Majority shareholders who own more than 50% of total shares issued have the most control over company operations and can pass ‘ordinary resolutions’, like appointing and removing director(s).
How Do You Value a Minority Shareholding?
Numerous methods exist to value a private limited company and determine a minority shareholding’s value. If no mechanism to calculate share value exists in the Articles of Association or shareholders’ agreement and a dispute arises during a buyout or other transaction between shareholders, the Court may decide the fair value of the shares, which will likely include a minority discount against the pro rata value of the holding.
