Two brothers inherited a large, closely held company from their father. One took active control and 70% of the shares; the other enjoyed his 30% interest over his lifetime, but when he died, distributed his shares to over 165 outsiders. Not surprisingly, the controlling brother authorized a reverse stock split to effectively “squeeze” out the beneficiaries’ fractional interests. They sued, and in an important new decision, the Delaware Chancery Court first ruled that “the fair value standard is…economically efficient and should be applied consistently to freeze-outs,” regardless of whether they take the form of a majority-controlled merger or reverse stock split.
More importantly for business appraisers, the court rejected one expert’s use of the guideline public companies method (GPCM), because his selected comparables were too large, more diversified, had better access to capital, deeper management teams, and different economic drivers—so much that they rendered the approach “meaningless” in this case. The court also rejected the expert’s capitalized free cash flow approach because it required too many adjustments. It accepted the capitalized earnings approach used by both experts—but criticized and made its own adjustments for R&D costs, non-recurring revenues, insider self-dealing, tax rate, earnings period, and the capitalization rate. In the latter, the court rejected the 6% company-specific risk premium (CSRP) by one expert because of the “inherent dangers of overestimating” this adjustment, replacing it with a more modest 2%.
Download the case digest: Because this is another “must-read” from the DE Chancery, we’ve just added the digest of Reis v. Hazelett Strip-Casting Corp., 2011 WL 303207 (Del. Ch.)(Jan. 21, 2011) to our free downloads page at BVResources. Click here for your copy.
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