United States

Valuation issues in dissenting shareholder cases

Understanding the case law is vital


Dissenting shareholder cases are what I refer to as business divorces. And just like its domestic divorce cousin, the major factors that impact the valuation of non-controlling interests in privately held companies in these cases is often contained not in statute, but in case law. Because each jurisdiction has its own case law, it is vital to be current on the rulings in the jurisdiction involved.

The following cases highlight three key valuation issues:

  • Standard of value
  • Built-in gains
  • Normalizing adjustments

Standard of value

Let's start out with the most critical issue in these cases­-fair market value or fair value.

Shawnee Telecom Resources v. Kathy Brown (decided by the Supreme Court of Kentucky), stated that fair value is the value of the proportionate shares as a whole. Further, the opinion states the rationale for this determination is that the minority shareholder has the right to receive his or her proportionate value of the stock in the company as a going concern, not based on a hypothetical sale to an outsider.

Jay Link v. L.S.I. (South Dakota) again stated that fair value is the proportionate value as a going concern, without regard to a discount for lack of marketability (DLOM) or lack of control (DLOC). Rolfe State Bank v. Charles Gunderson, et al. (Iowa) ruled that the DLOC and DLOM do not apply in fair value cases involving a reverse stock split designed to force the minority fractional shares out of the company.

Dawkins v. Hickman Family Corp. (Mississippi) gave the best summary of the issue by not only stating that fair value is defined as the fair market value without regard to the DLOC or DLOM, but by taking it one step further by listing 23 states that have statutes that have the same or similar definitions of fair value.1

Built-in gains

The issue of taking a deduction for the built-in gains in the valuation of a privately held company relates to the asset approach to valuation. The underlying concept is that a company holding appreciated assets would have to pay a capital gains tax on the sale of those assets. If the ownership of the company changes due to a sale of the stock of the company to new shareholders, the liability for the tax on the future sale of the appreciated assets held by the company stays with those assets. A number of tax court cases address this issue (Estate of Jelke v. Commissioner-100 percent deduction of the hypothetical tax as of the valuation date; Estate of Richman v. Commissioner-present value of tax to be paid sometime in the future). Those cases address change in ownership, rather than dissenting shareholders.

New York decided this issue in Giaimo v. Vitale. Giaimo moved to dissolve two family-owned C corporations that owned 19 residential buildings in Manhattan. Both parties used the asset approach to assess value and the results were similar. The court determined there should be no discount for DLOM. It also had to decide whether there should be a reduction in value for the built-in gains tax.

The New York court noted that the supreme courts in both Wyoming and Delaware declined to consider the tax consequences of the sale of the assets unless there is evidence that the corporation is actually undergoing liquidation on the valuation date. New York followed the contrary view-that it is irrelevant whether the corporation will actually liquidate its assets and that the court, in valuing a close corporation, should assume that liquidation will occur.

The state of Utah, in Resources International v. Mark Technologies Corp. decided a case involving a business that was winding down, the assets of which consisted primarily of appreciated undeveloped real estate. The company executed a 500:1 reverse stock split and then bought out the fractional shareholders. The minority shareholders sued. The court noted that Utah statutes call for fair value valuations for dissenting shareholders (see footnote 1). The court held that it is appropriate to deduct expected built-in gains tax, especially in the case where the company is expecting to liquidate its assets.

Normalizing adjustments

Normalizing the operating income and cash flow of a business refers to the adjustments made for non-recurring or non-operating income and expenses. Common adjustments include officer and shareholder compensation and benefits, related party transactions or other discretionary expenses that a hypothetical non-related investor would not pay. It is a common practice to not make normalizing adjustments when valuing a minority interest in a privately held company under the theory that a minority shareholder does not have the ability (i.e., authority) to make any changes in the operating practices of the company. Would the same principle be true in a dissenting shareholder case?

South Carolina, in Blackburn v. TKT and Associates, dealt with this issue. The minority shareholders asserted that the controlling shareholders were taking excessive compensation and motioned to be bought out of the company at fair value. The court found that the compensations were excessive and ordered a valuation. The valuation expert, inexplicably, prepared a valuation calculating net income and cash flow using the same compensation that the court found excessive. The court found that the valuation failed to comply with the agreed-upon income approach by not normalizing earnings for the excessive compensation.

New York also decided this issue in Zelouf International Corp. v. Zelouf. Due to numerous intra-family squabbles, one of the 25 percent minority shareholders sued to have her shares purchased at fair value. The record contains numerous instances of the majority shareholders improperly taking funds from the company. This case is interesting because both the parties and the court relied on a valuation prepared by Kevin Vannucci of RSM as the starting point in the determination of fair value. The court ruled that not only was the 25 percent shareholder entitled to a 25 percent proportionate interest in the company (without any reductions for DLOC or DLOM), but also an additional 25 percent of the itemized improper expenses taken out by the majority shareholders.


Valuations of privately held companies in dissenting shareholder litigation matters often involve complex valuation issues. Further, these issues may be treated differently in different jurisdictions. Therefore, it is imperative to involve a qualified valuation specialist, working closely with local legal counsel, to arrive at the proper conclusion to these types of cases.

[1] Alabama, Arizona, California, Connecticut, Florida, Illinois, Maine, Maryland, Minnesota, Missouri, Montana, New Hampshire, New Jersey, New York, North Carolina, North Dakota, Rhode Island, South Carolina, Utah, Vermont, West Virginia, Wisconsin and Wyoming.