Abstract: This article discusses a key issue in defensible business valuations: diversity of approach. A recent Tax Court case arose when a shareholder filed suit after a company announced a recapitalization agreement. The allegation was that the agreement significantly undervalued the company and therefore improperly transferred wealth and voting power from its minority shareholders to its primary debt holder. The plaintiff’s expert arrived at an exceptionally high value using only the discounted cash flow method. But the court rejected this approach, placing greater credence on the defense’s use of multiple valuation techniques.
Power of three
Court endorses triangular valuation approach
What makes for a defensible business valuation? Well, many things — but one key element is a diversity of approach. That is, if an appraiser uses several different methods to estimate value, his or her valuation will be more likely to hold up in court.
Although a few years old at this point, the Delaware Chancery Court’s 2011 decision in S. Muoio & Co., LLC v. Hallmark Entertainment Investments still provides a great example of the importance of multiple approaches. Here the court urged the use of a more robust type of business valuation that applies multiple techniques to “triangulate” a value range.
Dispute at hand
The case involved the recapitalization of Crown Media Holdings, Inc. by its controlling stockholder and primary debt holder, Hallmark. When the recapitalization was first proposed, Crown’s cash flows were insufficient to service its debt. After the recapitalization agreement was announced, a shareholder, Muoio, filed suit to stop it. The suit alleged that the agreement significantly undervalued Crown and therefore improperly transferred wealth and voting power from Crown’s minority shareholders to Hallmark.
At trial, Muoio’s expert relied solely on a discounted cash flow (DCF) analysis to calculate his $2.9 billion valuation of Crown — almost three times higher than any of the other valuations presented by Hallmark’s experts and advisors. Although Muoio’s expert conducted two other valuations, a comparable companies analysis (which produced a value of $803 million) and a comparable transactions analysis ($1.3 billion), the expert rejected those conclusions as “absurdly low” in comparison to his DCF analysis.
Wildly divergent results
In its opinion, the court included a chart to visually demonstrate “just how far off