Pity the trial court that recently was asked to value a pharmaceutical startup that, during the relevant period, was in serious debt but had high hopes for two drugs that could (and ultimately did) make the company very profitable. Moreover, the court confronted expert value determinations that resulted in a one-billion-dollar discrepancy. When the court devised its own valuation solution, neither party was satisfied, and both sides appealed.
Limited objective valuation data: The plaintiff and the defendant in this shareholder dispute founded a company that developed and marketed a form of fentanyl and different versions of dronabinol. The plaintiff, a minority shareholder, initially was in charge of the company’s operations and science. The defendant, who had controlling interest, was responsible for the financing. In early 2007, the company prepared for an initial public offering (IPO), acknowledging in SEC filings that its own success was “highly dependent” on the success of the two drugs in development. As the company underwent a change in corporate structure, the plaintiff’s role and standing diminished. In late 2007, various underwriters valued the company between $150 million and $200 million. The company abandoned the IPO in the fall of 2008.
As a result of two contested transactions that took place in 2008 and 2009, the controlling shareholder came to own the company in its entirety in exchange for his continuing funding. At the same time, the 2009 transaction effectively eliminated the plaintiff’s ownership interest. The plaintiff sued the company, the controlling shareholder, and the company’s directors, alleging breach of fiduciary duty and fraud. During the litigation, the company obtained FDA approval for the drugs. It went public in March 2013, and a March 2014 estimate put its value at almost $1.7 billion.
The trial court reviewed both transactions under the highest standard of review, entire fairness, and found the defendants liable as to the 2009 transaction. As a remedy, the court awarded the plaintiff the value of his proportionate share of the company at the time of the 2009 transaction. It noted, however, that determining a per-share value was difficult. There was “very limited objective data available for valuation” in this case, which meant any expert valuation risked being based “almost entirely upon subjective assumptions and predictions, now tainted by hindsight bias.” Here, the plaintiff expert’s adjusted book value method generated a $41.46-per-share price, whereas the defense expert’s discounted cash flow analysis produced a $0.07-per-share price. The court found it was impossible to produce a reliable fair value based on traditional valuation methods. It, therefore, looked to 2007 IPO valuations and decided the company then was worth $151.5 million, which resulted in a $7.3 million fair value for the plaintiff’s then ownership interest.
On appeal, the defendants claimed use of IPO valuations to determine fair value was improper. The Court of Appeals found there was no authority for this proposition. It also rejected the plaintiff’s claim that the trial court erred when it failed to award him rescissory damages in lieu of the fair value of his shares. The trial court “coped admirably with the evidence that was presented,” the appeals court concluded.
A digest for Kottayil v. Insys Therapeutics, Inc., 2017 Ariz. App. Unpub. LEXIS 1179 (Aug. 29, 2017), and the court’s opinion, are available at BVLaw.