It is not only what but also to whom that matters

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Published: 29 Jul 2015

Share price negotiation

Have you heard the story about two starving artists? Both are extremely talented, but one of them is friends with a king. Who do you think is likely to do well?

It doesn not matter which one of them is the better artist, because the one who is friends with the king will have an easier time selling his art.

The origin of this story can’t be traced but it’s based on common sense.

Connections can make a huge difference

For instance, if a majority shareholder holding over 75% is selling his or her interest in a company, the valuation is normally based on a proportion of the percentage interest in the total value of the company.

However, the valuation of a minority shareholding needs to take into account discounts for lack of marketability and limited influence on company management and profit distribution.

So when an investor received a letter of offer for his 21% shareholding in a private company from a larger (but not majority) shareholder, discounting the company’s pro rata valuation by 90%, he asked Sundial Tax & Finance Ltd for advice on whether to accept or decline the offer.

What do you think?  Accept or decline?

It is true that a minority interest of 21% will attract a significant discount as a buyer, owning no other shares in the company, would be in the same position as the seller.

However, the offer is being made by an existing shareholder with a 47% interest in the company. Consequently, this purchase would make the buyer the majority shareholder, with total discretion on appointment and dismissal of the company’s directors and profit distribution.

This connection makes for a far more attractive proposition to the buyer.

Share price negotiation

A counter offer was made by the seller, pointing out the effect of the majority shareholding, reducing the discount from 90% to 60%.

The negotiations were concluded with a reduced discount of 85% on the share valuation, adding a further £5,000 to the sale price. Although there was room for argument to increase the sale price further, the buyer threatened to withdraw unless his revised offer was agreed. 

Unless mismanagement of the company by the larger shareholder can be proved, there is not a lot that the seller can do other than accept the revised offer. Since relations between the two shareholders had been acrimonious for some years, it was unlikely that a better offer could have been secured, without incurring significant legal costs. In different circumstances, I would have expected a smaller discount (therefore a higher sale price) could have been agreed.

The Moral to this Story

This story demonstrates the benefit to a minority shareholder for the Articles of Association or the Shareholder’s Agreement , to contain Fair Value provisions, excluding any discount on valuation of a minority interest.

Secondly, case law now enables shareholders of quasi partnership companies to ignore discount on valuation of minority shareholdings, where all the shareholders have been working directors. Unfortunately, it did not apply for the whole period of share ownership in this case. 

So if you are seeking advice on negotiating the best share price for your company, please call David Cane at Sundial Tax & Finance Ltd on 0845 177 0036 or 07749 080 806.