Delaware Chancery OKs use of DCF and tax affecting in fair value proceeding

Owen v. Cannon, 2015 Del. Ch. LEXIS 165 (June 17, 2015)

A recent decision from the new Chancellor of the Delaware Court of Chancery has captured the attention of valuators for at least two reasons: the court's adoption of the discounted cash flow (DCF) method and its tax affecting of an S corporation.

The case involved a company’s former president who sued his ex-partners over a squeeze-out merger. In a joint action, he alleged breach of fiduciary duty and petitioned the court for a statutory appraisal of the value of his shares. The business was organized as a Subchapter S corporation.

The use of the DCF to determine the fair value of the shares represents a departure from recent rulings by the same court that has looked to the merger price as the most reliable indicator of value owing to the lack of reliable management projections. In contrast, in this case, the Chancellor expressly rejected one side’s attack on the projections, finding there was a “deliberate, iterative process over a period of three years to create, update and revise multi-year projections for the Company.” Accordingly, the projections formed the basis of the court's own DCF analysis.

Also noteworthy is the court's strict adherence to precedent that requires that a DCF analysis treat company earnings in a way that accounts for the tax advantages of being an S corp stockholder, i.e., tax affect. As part of the tax treatment discussion, the court addressed the issue of whether a valuation based on the controlling "Kessler" model must consider the company’s actual earnings distribution policy.

Read more about the court’s decision here.