In a recent court ruling, the Indiana Supreme Court determined that “there is no blanket rule prohibiting agreements that call for open-market concepts to apply to compulsory, closed-market transactions.” In the determination, the court allowed valuation discounts for lack of control and lack of marketability to be applied to the value of a departing minority shareholder’s ownership interest in a business. Such rulings must be considered as business owners and their advisors draft language to be included in shareholder or operating agreements.
The application of valuation discounts in the valuation of a departing shareholder’s ownership interest became a primary issue in Hartman v. BigInch Fabricators & Construction Holding Company, Inc. The appellant, a minority shareholder in BigInch Fabricators & Construction Holding Company, Inc., an Indiana-based company that operates in the gas and oil pipeline construction industry, was terminated from the Company in 2018, triggering a buyout provision in the Company’s shareholder agreement. Following the hiring of an independent business valuator to appraise the appellant’s interest, a disagreement between the sides centered around the valuator’s application of valuation discounts.
The Supreme Court ruled that the executed shareholder agreement, although not referring to the term directly, contemplated a minority shareholder buyout utilizing the fair market value standard of value. The “fair market value” standard, which has a commonly accepted definition within the International Glossary of Business Valuation Terms, warrants the application of discounts for lack of control and lack of marketability when determining the value of a minority interest in a closely held business. The shareholder agreement specifically referred to an “appraised market value,” which the court deemed to equate to fair market value.
In brief, although case law in many states specifically calls for the valuation of shares to be completed without the application of minority discounts in dissenting minority shareholder buyout issues, as they may be inequitable, the Indiana Supreme Court determined that the agreement in place was authoritative in the matter. Shareholders should be sure to consult the proper legal and business valuation advisors when drafting such documents for their businesses.