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When the debate comes as to the value of shareholdings many shareholders agreements provide very little assistance.
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Ambiguity in Shareholder Agreements - what you need to know
05 August 2015
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I just reviewed a valuation clause in an existing shareholder’s agreement for a company.
In summary the shareholders agreement sets out the following:
- If the members or respective buyer and seller cannot agree value, the Company’s accountant must determine it on the request of any member, the value being the greater of:
a) The value of the Company in accordance with its balance sheet at the relevant time and without any updating of assets values for that purpose; and
b) The value of the Company by valuing it on a multiple of the average earnings of the Company before interest and tax for the last 3 years, where the multiple is determined by 2 valuers as agreed between the respective parties.
- The deed then goes on and sets out how to appoint the 2 valuers and if the 2 valuers cannot agree on a multiple then it is to be the average
- Finally the deed states that the valuation will be binding on the parties affected by it
The background of this assignment is that one of the minority shareholders is going through a marital split and his minority shareholding needs to be valued for family law purposes. And so now what??
Clearly the methodology as set out in the shareholders agreement is not binding in relation to a family law valuation but can and should be used as a guide for the independent family law valuer. Let’s assume that in this instance the husband will retain his shareholding and pay his ex-wife out in cash. It is then equitable that the valuation for family law purposes be valued on the same basis as if one of the husband’s business partners were to pay him out, after all, based on current circumstances, this is what the husband is likely to get for his shares into the future.
However the above gives no guidance for the family law valuer if for no other reason than there is no agreed multiple. Additionally the family law valuer will not be bound in his valuation approach. For example, he may decide not to value the business based on average earnings over the last 3 years, he may take into account future events. This likely leads to the family law valuer coming up with a different value than if one of the husband’s business partners were to buy him out, which in turn may lead to an additional legal fight and costs, and of the husband overpaying or underpaying his ex-wife when it all pans out.
The solution is the more specific the valuation clause in shareholders agreements the better. I believe the valuation clauses in shareholders agreements should refer to an annexed schedule which is an agreed worked example of the business valuation. This worked example should stipulate the process for arriving at maintainable earnings and should stipulate the agreed multiple. This annexed worked example can then be revised and if agreed amended by all shareholders in agreement allowing for changes in business circumstances. Much better to know where you stand up front and as much as possible take away the ambiguity. This would then in turn give concrete guidance to in this example the family law valuer.
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