Abstract: When entrepreneurs team up to form a new (or combined) business, they often have the forethought to include business valuation provisions in their partnership or shareholder agreements. These provisions help facilitate clear and easy resolution in case an owner leaves the business. This article summarizes a recent case that demonstrates how simply drafting a business valuation provision may not suffice — hiring an outside expert to value the business on a routine basis can provide an added level of protection against protracted litigation.
- Kashmiry & Assocs., Inc. v. Ellis, 16 MA 0126, Ohio App., Jan. 26, 2018
- Kashmiry & Assocs., Inc. v. Ellis
Valuations can preempt shareholder agreement litigation
When entrepreneurs team up to form a new (or combined) business, they often have the forethought to include business valuation provisions in their partnership or shareholder agreements. These provisions help facilitate clear and easy resolution in case an owner leaves the business. However, a recent case demonstrates that simply drafting a business valuation provision may not suffice. Hiring an outside expert to value the business on a routine basis can provide an added level of protection against protracted litigation.
The owners of a merged insurance agency learned this lesson the hard way when the minority shareholder left the business. At least three rounds of litigation have ensued, largely due to the fact that the owners never had the company valued after the merger.
Valuation provision
In Kashmiry v. Ellis, the shareholders’ agreement provided that, if a triggering event occurred, the majority shareholder had the option to buy the minority shareholder’s stock. If he didn’t, the company would have to buy the stock based on an “agreement price” that could be calculated in one of two ways.
- Annual consensus. The shareholders could annually agree on the fair market value of the stock and issue a certificate of valuation that would be valid for a year.
- Outside appraisal. The shareholders could appoint a qualified appraiser when a triggering event occurred.
The shareholders’ agreement specified the factors a business valuation expert should use to determine price, giving “great weight to any prior valuations.”
When the minority shareholder was terminated in 2014, the majority shareholder chose not to purchase his shares. Unfortunately, no valid certification of valuation existed at the time of this triggering event. So the company hired a valuation expert who valued the shares at about $2,000 each.
Court positions
The trial court valued the minority shareholder’s interest at $7,500 per share, which was the price the minority shareholder had paid five years earlier. The court considered this purchase price a “prior valuation.” The majority shareholder appealed.
The Ohio Court of Appeals faulted the trial court for relying on the $7,500 purchase price as the sole indication of value. While the original price may be deemed a valuation, it was only one valuation, “and five years old at that.” Giving such a valuation sole weight was erroneous and contrary to the terms of the shareholders’ agreement.
To be continued
The appellate court remanded the case for another valuation of the stock, more than four years after the triggering event occurred. If the parties had obtained annual valuations, they might well have saved much time, money and aggravation.
© 2019
