As promised, we’ve been following Baldwin v. Bader, the U.S. District Court case that considers the novel question of how to value personal guaranties provided by corporate insiders to secure company debt. (See BVWire™ #70-2) Although it’s not uncommon for the owners and directors of small, closely held businesses to undertake the risk in return for financing, the insiders of the cash-poor, financially troubled company in this case received additional shares as compensation for extending their guaranties. Only one shareholder refused to participate, and later sued the directors for breaching their fiduciary duties by allegedly diluting his shares.
At trial, the directors offered an expert who relied on Valuing Small Businesses and Professional Practices, by Shannon Pratt, Robert Schweihs, and Robert Reilly (VSBPP), and information from a workshop by the Institute of Business Appraisers (IBA), to support his proposition that the directors’ risk was comparable to the risk of equity investors. But the dissenting shareholder objected, claiming that the authorities fail to give direct guidance on valuing insider guaranties apart from appraising a business. The court agreed, and precluded the evidence—but the directors were given a “second bite at the apple” when the presiding judge retired and other procedural issues merited a second Daubert hearing.
This time, in Baldwin v. Bader (July 28, 2008), the defendant directors offered new but similar authority from the just-released Cost of Capital (3d. ed., 2008), by Shannon Pratt and Roger Grabowski. The dissenting shareholder objected to the “eleventh hour” interjection of additional material. But a financial expert need not anticipate every “nano detail” that might come up in defending an opinion against Daubert, the court held. At the same time, Daubert does not permit a valuation technique that no expert has ever used before, and for which there appears to be no direct support in the BV professional literature—the defendants lost their expert evidence for the second and apparently last time.
What‘s your opinion? The court called the question a close one—a complete abstract of its long, carefully crafted opinion (which also details the ultimate decision on liability and damages) will appear in the October Business Valuation Update™. A full text of the court case is available at BVLaw™. We’ve already fielded some feedback on the decision: Did the court set the Daubert hurdle too high? Is there sufficient support among BV authorities for comparing the risk of insider guarantors to equity investors—especially those who receive additional shares as compensation for undertaking the risk? Add your opinion by emailing the editor, and we may feature your comments in an upcoming edition of the BVWire.