A New York trial court recently issued a decision in connection with the buyout of a minority shareholder that provides rich fare for valuation professionals. The court’s somewhat unusual (for New York) take on the use of a marketability discount is only one of the issues making the ruling a treat.
Sneak preview: The case involved three (roughly equal) partners who owned Planet Fitness franchises in two corporate entities. The minority owner sued the others, asking for a judicial dissolution, but they ultimately agreed to a fair value determination by the court. The plaintiff’s expert was a tax lawyer with no valuation experience. In contrast, the defendants’ expert was “a true valuation professional,” as the court called him. The plaintiff’s expert valued the two corporations at over $162 million and the seller’s interest at over $53 million. The defendants’ expert valued one of the entities at $6.2 million and the other at $208,000. He concluded the plaintiff’s one-third interest was worth approximately $2.2 million.
The court allowed the plaintiff’s expert to testify on valuation but completely discredited his work product. At the same time, it had some harsh words for the defense expert’s valuation as well. Ultimately, the court decided to use the defendant expert’s basic approach and modify it to raise the value of the plaintiff’s interest to $8.8 million.
No justification for DLOM: One of the court’s major adjustments was nixing the 35% marketability discount the defendants’ expert had applied. His report showed that only a portion of the discount rate related to marketability, and much of it related to a potential tax liability the expert saw, the court noted. However, he was unable to adequately explain when the unfavorable tax treatment would set in, the court said. It also dismissed the expert’s rationale that there would be a prolonged holding period. His effort “to maximize Defendants’ position by a ‘high-end’ discount is thus not persuasive,” the court said. Citing the Zelouf case, the court noted that no New York appellate court ever held that a marketability discount was mandatory—especially not in a situation where the defendants made it clear that they were not planning to sell.
Other issues: The court picked at other aspects of the defense valuation, including the defense expert’s decision to normalize historic income by nearly doubling officer compensation; his “roller-coaster” revenue growth model; and his decision to tax affect one company’s earnings by 18.5% to account for its being a pass-through entity. The latter suggested he “was unduly focusing on the buyer’s side of the equation,” the court noted.
Takeaway: In the latest New York statutory fair value ruling, the court noted that while it would have considered an entity-level discount for lack of marketability based on certain transfer restrictions operating on franchisees, the expert’s failure “to provide a basis for calculating the appropriate amount of the discount,” as well as other factors, militated against the use of a DLOM.
The case is La Verghetta v. Lawlor, Index No. 5934/2014, N.Y. Sup. Ct. [County of Westchester](March 9, 2016). An extended discussion of the case and the court’s opinion will appear in the May issue of Business Valuation Update and at BVLaw. A digest and the court’s opinion for Zelouf Int’l. Corp. v. Zelouf, 2014 N.Y. Misc. LEXIS 4341 (2014) are available at BVLaw.