Trial court’s IPO valuation in fair value proceeding holds up on appeal

Kottayil v. Insys Therapeutics, Inc., 2017 Ariz. App. Unpub. LEXIS 1179 (Aug. 29, 2017)

A recent case shows just how difficult it is to value a startup. Here, there was an extra challenge because the subject was a pharmaceutical venture that required years of funding for the development of two drugs working toward FDA approval. The trial court needed to determine the fair value of the plaintiff’s interest prior to the company’s ultimate success. It found the parties’ expert appraisals were not helpful and came up with its own approach, which, in turn, prompted both parties to appeal.

The plaintiff and the defendant founded a company that developed and marketed a form of fentanyl and different versions of dronabinol. The plaintiff, a minority shareholder, initially was in charge of the company’s operations and science. The defendant, who had a controlling interest, was responsible for the financing. In early 2007, the company prepared for an initial public offering (IPO), acknowledging in a public statement that its own success was “highly dependent” on the success of the two drugs in development. At that point, the FDA had not approved either drug. The company abandoned the IPO in the fall of 2008.

The plaintiff eventually lost his position in the company and, as a result of two contested transactions that took place in 2008 and 2009, also lost his ownership interest. Meanwhile, the defendant controlling shareholder came to own the company in its entirety. In March 2013, the company obtained FDA approval for both drugs, and it went public in March 2013. A valuation estimate of March 2014 said the company was worth $1.7 billion.

The plaintiff challenged the 2008 and 2009 transactions in a lawsuit, alleging a breach of fiduciary duty by the controlling shareholder and members of the board of directors as well as fraud. The trial court found the defendants liable as to the 2009 transaction. It awarded the plaintiff the value of his proportionate share of the company at the time of the 2009 transaction, noting, however, that determining a per-share value was hard. It said there were “very limited objective data available for valuation” in this case, which meant any expert valuation risked being based “almost entirely upon subjective assumptions and predictions, now tainted by hindsight bias.” Here, the plaintiff expert’s adjusted book value method generated a $41.46-per-share price, whereas the defense expert’s discounted cash flow analysis produced a $0.07-per-share price.

Click here to find out more about the trial court’s valuation solution and the Court of Appeals response.