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Articles From Brisbane Consulting Group

Shareholder Buyouts: Comprehensive Agreements Are Essential

Shareholders’ agreements often contain buyout provisions regarding what should happen if a shareholder dies, becomes disabled or otherwise leaves the company.

However, these provisions sometimes prescribe methodology or use undefined terminology that may be subject to different interpretations.

For example, the Superior Court of Pennsylvania recently had to decide whether a trial court correctly interpreted the term “adjusted” in the context of a shareholders’ agreement that called for “adjusted net book value” in voluntarily terminations.

Here’s what the court decided — and why it’s important to clearly define business valuation terms in shareholders’ agreements. (D. Allen Hornberger v. Dave Gutelius Excavating, Inc., No. 103 MDA 2017, Pa. Sup. Ct., December 15, 2017.)

Redeeming a Departing Shareholder

The plaintiff worked as a land surveyor for Dave Gutelius Excavating (DGE) from March 1999 until November 2011. In February 2006, he purchased 10 shares of the company’s stock and signed a shareholders’ agreement. The agreement allowed the company to redeem a departing owner’s stock at “adjusted net book value,” as calculated by the company’s CPA firm.

The buyout provision expressly required the CPA-valuator to consider three specific adjustments:

1. “No allowance shall be made for the goodwill or trade name of DGE.”

2. “Accounts payable shall be taken at face amounts less discounts deductible therefrom, and accounts receivable shall be taken at face amount less discounts less a reasonable reserve for bad debts.”

3. “All real property … and all tangible personal property … shall be taken into account at their fair market value.”

When the plaintiff voluntarily left the company in 2011, DGE offered to redeem his shares for $4,280 each. The company’s CPA based that amount on the following calculation:


The company’s CPA applied valuation discounts for lack of control and marketability, because the plaintiff owned only about 1% of the company’s stock outstanding. And he reasoned that such discounts were “customary” when estimating fair market value.

The plaintiff filed suit, alleging that the shareholders’ agreement didn’t call for valuation discounts for lack of control and marketability. His expert estimated that the interest was worth $6,436 a share, based on the company’s value on a controlling, marketable (undiscounted) basis ($6,371,402 ÷ 990 shares). The expert testified that the three mandated adjustments listed above were exclusive, and the shareholders’ agreement didn’t permit further adjustments.

Factoring Professional Judgment into the Equation

The trial court sided with DGE’s expert, and the Superior Court of Pennsylvania affirmed. The appellate court concluded that “all three experts appeared to agree that minority interest and lack of marketability discounts are customarily applied when valuing shares in closely held corporations, no matter which valuation method is used.” Furthermore, the agreement didn’t preclude “the use of fair-market-value-based adjustments to the book-value calculation.”

Instead, the use of an independent CPA to determine the adjusted net book value of a shareholder’s interest implies the use of professional judgment. Such judgment includes the application of “conservative” valuation discounts for lack of control and marketability.

Recipe for a Comprehensive Buyout Provision

To avoid misunderstandings and delays when redeeming a departing shareholder’s interest, a buyout provision should contain the following eight key ingredients:

1. Appropriate standard of value (such as fair market value or fair value),

2. Definition of the standard of value,

3. Exhaustive list of applicable valuation adjustments and discounts,

4. Relevant method of quantifying valuation adjustments and discounts,

5. Effective date of the valuation (for example, the year-end nearest the triggering event),

6. Buyout terms (including who will buy the interest and how payments will be made),

7. Appraisal/redemption deadline (for example, within 30 or 90 days of the triggering event), and

8. Method of appraisal (such as a fixed price, a prescribed formula or the use of a credentialed business valuation professional).

This list outlines some of the relevant valuation issues that come up during shareholder buyouts. Because market conditions change over time, it’s important to review buyout provisions regularly to determine whether the shareholders’ agreement needs to be updated. The input of a business valuation professional can help reduce shareholder disputes when a triggering event happens.

Key Takeaway

When drafting buyout provisions for shareholders’ agreement, it’s a good idea to work with a business valuation professional. These specialists can help ensure that all the value-related bases are covered, including how terms are defined, addressing specific adjustments and prescribing methods to use when redeeming a shareholder’s interest. By being proactive, you may avoid the need for litigation altogether.



Lou is the Managing Director of Brisbane Consulting Group in charge of business valuations, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution. He has been engaged in several forensic accounting cases and has served the judiciary as a court appointed expert and receiver for financially troubled companies. He has testified as an expert witness in State Supreme Court and Federal Court. Lou has also been engaged in the quantification of lost income in determining business interruption claims for insurance adjusters. 


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