When shareholders in a business come into conflict with one another or with management, buying out one side’s shares often provides the best way to resolve the shareholder dispute. However, for private companies, buying out shareholders requires setting a valuation of the business. Unfortunately, determining a business valuation can open a new set of disputes between shareholders or between shareholders and corporate management.
Why Valuation Disputes Arise
Shareholders and corporate management may have valuation disputes over issues such as the correct valuation date or the true value of the business. Disputes frequently arise when parties obtain separate, conflicting expert valuation opinions, even when experts have reviewed the same financial records or future projections. Parties may raise disputes for personal or strategic reasons, including undervaluing shares to reduce the payout to departing shareholders. Parties can also disagree over the interpretation of the terms of the company’s buy-sell agreements, including the process for determining business valuations.
Key Legal Principles Under Michigan Law
The Michigan Business Corporation Act governs shareholder buyouts. For example, Michigan law allows corporations to repurchase their shares if, after the purchase, the corporation still has outstanding shares with voting rights and an unlimited right to receive the business’s assets in the event of dissolution. The MBCA also allows a shareholder to bring an action alleging oppression by the directors or shareholders in control of the corporation, in which the shareholder can seek relief that may take the form of a court order requiring the corporation to purchase the shareholder’s shares at fair value.
Valuation disputes in Michigan shareholder buyouts can arise from the distinction between fair value and fair market value. Legal and accounting professionals define fair value as the price at which a party would sell an asset in an orderly transaction. Conversely, fair market value constitutes the price that an asset would sell for in a hypothetical sale between a willing buyer and seller in which neither party faces pressure to consummate the transaction and both parties have a reasonable knowledge of the market.
Common Valuation Methods
Parties in a shareholder buyout may use various valuation methods to determine a business’s value. The type of valuation method used may depend on the business’s industry and its stage in the life cycle (e.g., startup, emerging company, established business). Common valuation methods include:
- Asset-Based Approach – The asset-based approach determines a business’s value by adding the book values of all the business’s assets and subtracting the total liabilities of the company.
- Income Approach – The income approach calculates the future cash flow of the business discounted to present value.
- Market-Based Approach – The market-based approach determines a business’s value by evaluating recent transactions, such as business sales or equity capital raising, involving comparable companies.
Resolving the Dispute
Parties can resolve a valuation dispute during a shareholder buyout through various means, including:
- Relying on independent valuation experts or forensic accountants
- Having alternative dispute resolution agreements that require parties to resolve valuation disputes through mediation or arbitration instead of litigation
- Having well-drafted buy-sell agreements that include clear valuation procedures
- Keeping thorough financial documentation to facilitate business valuations
Tips for Preventing Valuation Disputes
Best practices for preventing valuation disputes that could derail shareholder buyouts include:
- Incorporating clear valuation formulas in corporate governance documents or buy-sell agreements
- Adopting periodic valuation policies to have an agreed-upon reference number
- Maintaining accurate financial records
- Developing procedures for shareholder exits as early as possible
Contact a Business Attorney
A business valuation can help you resolve a shareholder dispute through a buyout process. Contact August Law, PLLC, today for a confidential consultation with our legal team to learn more about how to resolve conflicts over business valuations during shareholder buyouts in Michigan.