Private company valuations present challenges because shares are not traded on a public exchange. As discussed in our prior post on How to Value Shares in a Private Company, there are certain factors that should be taken into account in determining what a company is worth. However, parties can still disagree about how those factors are applied by an appraiser. To minimize disputes over appraisals of a private company, additional steps should be taken.
Establish a Formula for Determining Value
Most disputes over valuation occur when a co-owner or partner exits the business, either voluntarily or involuntarily, and the other owners or the company want to purchase the shares of the departing owner. Best practice is to execute a buy-sell agreement in advance that sets forth what happens in the event an owner exits the business. That agreement should include a formula for calculating the value of shares to reduce potential conflicts.
Have a Process for Selecting an Appraiser and Conducting the Appraisal
A method for selecting appraisers should also be in the buy-sell agreement. The appraiser should be a neutral person with no interest in the outcome. Ideally, the parties should mutually agree to the appraiser, but if they don’t, they can provide that a trusted neutral third party will select the appraiser. Examples might include an accountant, lawyer or other business advisor.
The agreement can also specify that once the appraisal report is completed, each side has the opportunity to review and comment on it. If the results are still disputed, there may be additional procedures for resolving the conflict, such as getting a second appraisal and either accepting those results or splitting the difference between the two appraisals. In addition, the agreement should provide that any remaining conflicts go to mediation or arbitration. Alternative dispute resolution will be discussed further in a future post.
Once the appraisal is finalized, discounts may be applied to reduce the valuation. These include a lack of control discount, which is used when a buyer is purchasing less than a majority interest in the company. The shares are less valuable because the new owner does not have full control over how the business will be operated. The lack of marketability discount is also commonly applied to private companies. Since it is difficult to determine the value of a private company and there is a limited market for shares, the shares are discounted to reflect that reality.
Consult an Attorney to Advise Regarding Proactive Steps and Resolving Disputes Over Appraisals
Implementing these steps with the assistance of an experienced attorney can help minimize disputes over appraisals and resolve them quickly when they arise. Our attorneys advise companies of all sizes regarding taking preventive measures to reduce their risks and address disputes efficiently. If you own an interest in a private company, contact us to discuss how we can help your business.