Third time’s a charm? A nasty shareholder dispute that has lasted for two decades and featured rock-star valuators recently prompted a third appeals court ruling related to the marketability discount.
Case for DLOM: A sister and two brothers owned equal shares in a family trucking business. In 1996, one brother filed an oppressed shareholder action claiming his siblings tried to oust him from the company. The trial court found that the plaintiff brother in fact was the oppressing shareholder and ordered him to sell his interest either to the company or to the two siblings at fair value.
Both parties retained well-known appraisers. When the first trial court set a value without conducting an evidentiary hearing, the parties appealed. On remand, a different trial court heard valuation testimony and largely adopted the calculation the plaintiff’s expert proposed. It was based on a discounted cash flow (DCF) analysis. A second appeal followed. The appeals court affirmed nearly all aspects of the trial court’s value findings but said the valuation should have included a marketability discount.
Although a marketability discount was only applicable under “extraordinary circumstances” in a forced buyout situation, it was justifiable here because the plaintiff-seller had engaged in conduct that harmed the two other shareholders (defendants) and necessitated the forced buyout. Accordingly, the appeals court remanded again, ordering the trial court to determine whether the prevailing DCF analysis embedded a DLOM and set the applicable DLOM rate.
On the low end of spectrum: A third trial judge (two trial court judges had retired during the litigation) first found that, when the prevailing expert built up his discount rate for the DCF analysis, he did not specifically account for illiquidity. In the valuation trial, he had insisted a marketability discount was inappropriate because the company was successful and would likely take no longer to sell than other closely held companies of similar size and nature with assistance from “the right business intermediary.” He also believed the other shareholders would not lose liquidity during the marketing period.
As for the appropriate discount rate, the new trial judge noted that the buyers’ expert had valued the company under a market approach and had considered risk factors specific to liquidity—which were pretty much the same factors the opposing expert considered for his discount rate—to arrive at a 35% DLOM. A rate that high would unduly punish the seller and give a significant windfall to the buying shareholders, the trial court said. Case law and studies suggested a broader range, starting as low as 20%, depending on the equities in a given case. Here, a 25% DLOM was appropriate.
The parties appealed anew, but the reviewing court affirmed. It said that neither side had made a convincing argument for second-guessing the trial court’s “thoughtful and well-reasoned determination in this most difficult case.”
Takeaway: In building up the discount rate underlying his DCF analysis, the prevailing expert did not specifically adjust for lack of marketability (illiquidity). Therefore, an independent 25% DLOM was applicable to the valuation.
Find an extended discussion of Wisniewski v. Walsh, 2015 N.J. Super. Unpub. LEXIS 3001 (Dec. 24, 2015) (Wisniewski II), in the March edition of Business Valuation Update; the court’s opinion will be available soon at BVLaw. A digest of the prior appeals court decision, Wisniewski v. Walsh, 2013 N.J. Super. Unpub. LEXIS 724 (April 2, 2013), is also available at BVLaw.