This month's commentary does not feature bottles of red or white (with apologies to Billy Joel) - though other beverages are involved - now read on!
A regular feature of one of the business valuation conferences I attend is a panel discussion at which the burning issues in the valuation arena are discussed. The last time I attended this session, the moderator stipulated that any panelist who said "it depends" in their response had to make a contribution to charity. Unfortunately, "it depends" is so often the most appropriate answer to these knotty questions - and this has been highlighted by judicial pronouncements in the state of New York in two prominent cases involving shareholder rights.
In Zelouf International Corp. v. Zelouf, 2014 NY Slip Op 51462(U) [Sup Ct, NY County Oct. 6 2014], the court was dealing with a case where an uncle and nephew had flagrantly pillaged the family fabric wholesaling company to the exclusion of another uncle who owned 25% of the company. (Throughout the proceedings, this uncle was in a vegetative state after a failed surgery - the court was dealing with some fine upstanding citizens). The court required the company to buy out the minority shareholder at "fair value". One of the issues was whether a discount for lack of marketability ("DLOM") should be applied to the value of the 25% interest in question.
The judge ruled that New York law did not require that a DLOM should be applied in determining fair value. The judge noted that while there was no prospect of a sale of the company, the majority owners were receiving significant cash flows from the company's operations. They were therefore not suffering from the company's lack of liquidity and the judge determined that neither should the minority shareholder.
Fast forward only one week, when the New York courts were wrestling with the DLOM issue again, this time in the case of Ferolito v. Arizona Beverages, USA LLC (2014 NY Slip Op 32830 (U)). Here, Mr. Ferolito, a 50% owner of the very successful Arizona Iced Tea business was being bought out by the other owner in lieu of the company being dissolved. In this case, the judge applied a 25% DLOM to the "fair value". This was despite the fact that both the company and the 50% shareholding being valued had been the subject of interest from a number of buyers including Nestle, although all of these ultimately failed for one reason or another. The judge said these offers were not bona fide offers and did not remove the difficulties the shareholders would have had in attempting to liquidate their shares.
The judge distinguished the Zelouf case on the grounds that in that case the judge had determined that the liquidity risk was "more theoretical than real", whereas in the Arizona Iced Tea case the failed negotiations for sale showed it was alive and well. The company was therefore valued by the court at $1.5 billion after the application of the DLOM - so we don't have to feel too bad for Mr. Ferolito.
As ever, facts and circumstances appear to dictate which way the courts will decide on these issues. Is it too far of a stretch to suggest that equity in the Zelouf case was on the side of the minority shareholder and this influenced the final decision?