How to value unquoted shares

Bruce Jones, partner at law firm Bircham Dyson Bell, reflects on the legal issues surrounding the valuation of unquoted shares.

Valuing the shares of an unquoted company is a job for an accountant, a banker or some other financial expert. It is most definitely not a job for a lawyer; lawyers don’t do numbers. Moreover, valuation is an inexact art rather than a precise science, with the results of the same valuation exercise likely to be as different as the experience and opinions of the two valuers carrying out the exercise.

The vagaries of the valuation process do not matter if there is a willing seller selling unquoted shares to a willing buyer, where both parties are free to negotiate the terms. The trouble is that unquoted shares can often only be sold subject to restrictions, which act to distort, or even dictate, the market. In such circumstances, the law has a big role to play in determining a price that is fair to both the seller and the buyer.

Sometimes the shareholders of a company will have had the foresight to have agreed (in the articles of association or in a shareholders’ agreement) a means of valuing shareholdings in the event that a particular shareholder wishes to sell his shares. All too often however, the mechanism provided for is vague or not far reaching enough to cover the circumstances of the sale being contemplated.

A common formulation in shareholders’ agreements provides, in the absence of agreement between the parties, that an independent expert will determine what a fair value should be. The court will attempt to do a similar job if the parties have not reached advance agreement on the means of valuation.

This begs the question: what do we mean by “fair”? If the parties have not stipulated to the contrary, the law is likely to conclude that the fair value of an unquoted share should take account of the size of the stake being sold, with the result that a substantial discount should be applied to sales of minority stakes.

Attention is also paid to the restrictions, if any, that apply to the shares. For instance, it is a standard provision in many private companies’ articles of association that the directors have an absolute power to refuse to register any transfer of shares, a factor that leads to a substantial discount being applied to any share valuation.

The lesson is that prospective shareholders in an unquoted company would be well advised to agree among themselves in as much detail as possible the way in which their respective stakes will be valued on an exit – if they do not wish to end up with a nasty surprise when the time for departure arrives and the law fills in the gaps that the parties have left.

Of course, there is only so much that shareholders can do. When business relationships fail – perhaps because a minority shareholder is aggrieved at the direction the majority is taking a company – a forced exit may be on the cards. Fair value in these circumstances is very different. The court takes the view that an unquoted share should be valued as representing an equivalent proportion of the total issued share capital. That is, without a discount being applied for its being a minority holding. Nor will a discount be applied because the only buyer(s) in contemplation is the other shareholder(s) rather than a willing buyer on the open market.

Fairness in this sense is not just about fair valuation, but also about fairness of the circumstances in which valuation is taking place. The court does not compound the unfairness to a party who is a reluctant seller owing to unfairly prejudicial conduct of the majority owners by applying an unfair valuation process.

Fair’s fair? Perhaps it is not what you thought.

Nick Britton

Nick Britton

Nick was the Managing Editor for when it was owned by Vitesse Media, before moving on to become Head of Investment Group and Editor at What Investment and thence to Head of Intermediary...

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Company valuation