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04 August 2017

Falling out with a business partner: companies, unfair Prejudice, valuation and the minority discount

Introduction

I have fallen out with my business partners and we jointly own the company: what do I do next? How do I get out or how do I get him out?

In this context the two most commonly asked questions (apart from can I actually get out?) are, how little can I pay my business partner for him to get out of the company or, on the other side, how much can I get to go? Much depends on the attitude adopted by the parties.

Unfair prejudice disputes

Minority shareholders in private companies may, if they are being treated unfairly treated, petition (note the language) the Court for the majority shareholder to buy them out at ‘fair value’. Not every instance of unfairness can result in a Petition but the classic example is when the majority shareholder excludes the minority shareholder from a management position and then fails to declare a dividend (so that the minority can share in the profits) whilst at the same time they are taking out excessive sums as a salary.

However, just because a minority feels he is being oppressed does not make it so. The Courts can be reluctant to interfere with shareholders rights set out in the articles.

Valuation and discount

Liability aside, where a minority shareholder alleges that he has been oppressed with good reason, the real argument is how much should the majority pay for their shares? Broadly speaking this is a two stage exercise: (1) the valuation of the company as a whole and (2) whether a discount should be applied.

Valuation

First there will be arguments about the basis for the valuation of the company and any multiplier that should be applied (if any) to its turnover/profit or other metric. This is the province of expert valuers who should be instructed as soon as possible. However, then the discount will be assessed. Again there is some expert evidence to consider, but the discount/no discount issue is taken in the round.

Discount

The majority shareholder will say that a minority shareholding in a private company is not worth its pro rata valuation: they will say that a discount should be applied as there is no market for the shares, and the shares do not give control. Who would buy a minority share in a company when no monies are being received as a dividend?

It could be put as simply as this: control attracts a premium; lack of control ‘attracts’ a discount.

If a discount is applied it may reduce the minority shareholder’s value by between 30% to 60% and that discount is applied only after all the arguments about the value of the company are over. The majority shareholder will go out of his way to say that the entire value of the company is depressed, for instance due to lack of forward orders and then a discount is applied on that depressed value.

Fairness and quasi partnership

The issue is all about ‘fairness’. Until recently, if it could be shown that the shareholders were ‘quasi partners’ then no discount would be applied. If there is no quasi partnership then the question of a discount was more uncertain. Minority shareholders were very keen to show that they were quasi partners and majority shareholders were very keen to show that the minority shareholders were merely investors.

What is a quasi-partnership? Whilst not necessarily easy to define, in practice this is best identified where a small number of individuals who, although trading as a limited company, are in fact operating as if they were in a partnership, with the members having a relationship of mutual trust and confidence in each other.

A change in the law?

The uncertainty (over whether a discount should be applied where there is no quasi partnership) has been thrown into doubt by one of the leading practitioners Robin Hollington QC (sitting as a deputy High Court Judge). In 2014 he suggested that:

‘the general rule is that there should be no discount for a majority shareholding unless [the minority shareholder] acquired the shares at a discount.’

The current situation appears to be a (rebuttable) presumption that the discount does not apply even if there is no quasi partnership. However, it is still unclear.

Example

Using an example, let us say that the pro rata value of a company is £10 million on one expert valuation basis and £5 million on another. As can be seen a good expert is crucial. Assuming a 60/40 split on the shareholding between the majority and minority and assuming a (finger in the air) 40% discount, then the minority shareholding could be worth as little as £1.2 million (40% of £5 million at a 40% discount) to £4 million (40% of £10 million with no discount). That is worth arguing about.

Get a good valuer and see a solicitor quickly as there may be some manoeuvering to do to get into a better the position, whichever side of the fence you are on.

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