Should a discount be applied in the valuation of a minority shareholding in a private company?
On the face of it, the answer to this question is a conditional yes. However, much depends on the circumstances and the outcomes may be unexpected; in certain dispute-related situations, when a discount might be expected the opposite may apply and vice versa. This article looks at a recently published judgment from the High Court that sheds some light on what can be a significant and controversial issue, particularly in the valuation of a minority shareholding for buy-out purposes in a shareholders’ dispute.
First some background, in outline.
In short, unless there is a requirement to proceed otherwise, ordinarily a valuation of a minority shareholding will be subject to a significant discount.
Under applicable UK company law, separately held equal voting-share shareholdings have different levels of control over the subject company. This may be by reference to the shareholding itself, or as a tactical holding with other shareholders.
Generally, although not a direct relationship because of how voting influence is arranged, the smaller the relative proportion held, the less relative control the particular holding has. Thus, although the shares may have equal voting rights, effectively, shares which are part of a very small holding may have no controlling influence. In contrast, shares which are part of a substantial holding may have full controlling influence.
As a result, for valuation purposes in terms of an open market sale, a shareholding that offers less control is treated as less attractive than one offering greater control. Therefore, ordinarily, in this context, the valuation of a minority shareholding is subject to a ‘minority discount’: this is principally to address any associated control limitations, and any assessed consequent adverse impact on its marketability.
In contrast, for valuation purposes under the terms of Articles of Association, or a Shareholders’ Agreement, a minority discount may not apply if only a simple proportional basis is required.
However, in the context of a dispute (“contentious valuations”) involving a minority shareholding, be it in a court litigation or arbitration process, subject to the significance of the applicable Articles of Association or Shareholders’ Agreement, the court may determine to apply, or not apply, a minority discount as a means of administering justice between the parties.
This is exemplified in the following extract(s) from a recently published (May 2021) judgment1 by the High Court (Chancery Division).
- The case concerned a petition under Section 994 of the Companies Act 2006 for unfairly prejudicial conduct of the subject company’s affairs.
- The petition was brought by a shareholder and the sole director of the company as Petitioner (“the Petitioner”). This was principally against the former co-director who was also a shareholder (“the Respondent”).
- The order sought was, amongst other things, that the Respondent sell his shares to the Petitioner at a price to be determined, with a discount to reflect that the Respondent
“…holds only a minority…” of the shares.
- There was also a cross petition.
- The subject shareholding amounted to 25% of the issued shares of the company.
“… Minority discount
107. A minority discount is not usually appropriate in the case of a quasi-partnership. In Sunrise Radio Limited  EWHC 2893 (Ch) His Honour Judge Purle QC, sitting as a judge of the High Court, explained:
290. It is well established that an undiscounted valuation is usually appropriate when the successful petitioning shareholder is a quasi-partner as that expression is used in this branch of the law. Moreover, in Strahan v Wilcock  2 BCLC 555, Arden LJ, with whom Richards and Mummery LJJ agreed, commented at 562 that it was difficult to conceive of circumstances in which a non-discounted basis of valuation would be appropriate where a quasi-partnership relationship did not exist. This point was expressly left open, however.
291. In Irvine v Irvine (No 2)  1 BCLC 445, Blackburne J observed as follows:
A minority shareholding, even one where the extent of the minority is as slight as in this case, is to be valued for what it is, a minority shareholding, unless there is some good reason to attribute to it a pro rata share of the overall value of the company. Short of a quasi-partnership or some other exceptional circumstance, there is no reason to accord to it a quality which it lacks.
292. The recognition in that case of “some other exceptional circumstance” is a less narrow formulation that [sic] that posited by the Court of Appeal in Strahan, and points to the fact that there is no inflexible rule.’
108. This is not an inflexible rule however. In O’Neill Lord Hoffmann said:‘… the offer must be to purchase the shares at a fair value. This will ordinarily be a value representing an equivalent proportion of the total issued share capital, that is, without a discount for its being a minority holding. The Law Commission (paras 3.57 to 3.62) has recommended a statutory presumption that in cases to which the presumption of unfairly prejudicial conduct applies, the fair value of the shares should be determined on a pro rata basis. This too reflects the existing practice. This is not to say that there may not be cases in which it will be fair to take a discounted value. But such cases will be based upon special circumstances and it will seldom be possible for the court to say that an offer to buy on a discounted basis is plainly reasonable, so that the petition should be struck out.’
109. I note too the observations of Nourse J in Re Bird Precision Bellows Limited  Ch 419 at 430:
‘I would expect that in a majority of cases where purchase orders are made … in relation to quasi-partnerships the vendor is unwilling in the sense that the sale has been forced upon him. Usually he will be a minority shareholder whose interests have been unfairly prejudiced by the manner in which the affairs of the company have been conducted by the majority. On the assumption that the unfair prejudice has made it no longer tolerable for him to retain his interest in the company, a sale of his shares will invariably be his only practical way out short of a winding up. In that kind of case it seems to me that it would not merely not be fair, but most unfair, that he should be bought out on the fictional basis applicable to a free election to sell his shares in accordance with the company’s articles of association, or indeed on any other basis which involved a discounted price. In my judgment the correct course would be to fix the price pro rata according to the value of the shares as a whole and without any discount, as being the only fair method of compensating an unwilling vendor of the equivalent of a partnership share. Equally, if the order provided, as it did in In Re Jermyn Street Turkish Baths Ltd  1 W.L.R. 1194, for the purchase of the shares of the delinquent majority, it would not merely not be fair, but most unfair, that they should receive a price which involved an element of premium. …”
In summary, the court concluded in the circumstances, amongst other things:
- The company was “…in the nature of a quasi-partnership from the outset…”.
- However, a minority discount should be applied notwithstanding the quasi-partnership determination. The extent of applicable discount was not dealt with as the proceedings concerned liability and not quantum.
In this regard, the following further extract from the judgment is noted:
As to whether a minority discount should be applied, the starting point is that, where the court is dealing with a quasi-partnership, it will not provide for a discount where an innocent vendor is a minority shareholder. I bear in mind however the last sentence of the passage of Nourse J’s judgment in Re Bird Precision Bellows Limited, which I repeat for convenience here:
‘Equally, if the order provided, as it did in In Re Jermyn Street Turkish Baths Ltd.  1 W.L.R. 1194, for the purchase of the shares of the delinquent majority, it would not merely not be fair, but most unfair, that they should receive a price which involved an element of premium.’
This is reflective of the position here. It is clear that [the subject Respondent] created a situation whereby he and [the Petitioner] could not continue in business together. The agreed solution is that [the Petitioner] should buy out [the Respondent’s] shares. I do not see why [the Petitioner] should be required to pay a premium for a buy-out to remedy a situation that he did not engineer, even though his reaction to it may itself be criticised. …”
Valuations of private company minority shareholdings will have their ‘ordinary’ complications. However, in contentious and potentially contentious valuations, subject to the significance of applicable Articles of Association and/or Shareholders’ Agreement, an additional layer of complication can emerge involving matters that may be considered relevant by a court or adjudicating tribunal. This may include the relationships between shareholders, the nature of the shareholding, and doing justice between the parties. In these circumstances a minority discount for a minority shareholding is not ‘a given’. Accordingly, professional valuations advice in this regard, through to the giving of expert witness evidence in court or arbitration proceedings, should be for those with suitable expertise and experience in this area.
1 McMonagle v Harvey & Others  EWHC 1374 (Ch)
“Please note, the author is an experienced forensic accountant, and Chartered Arbitrator, and this article is prepared for general interest purposes only. It does not stand as, and is not intended to be, legal advice, and should not be relied on as such. Should a reader require legal advice on matters similar to those discussed in the article, then they should seek such advice from a suitably qualified and experienced legal expert.”