In its May 5, 2020 decision, Hartman v. BigInch Fabricators & Construction Holding Company, Inc., 2020 WL 2121471 (Ind. Ct. App. 2020), the Indiana Court of Appeals provided some overdue clarity for shareholders of closely held entities. To keep pace with neighboring jurisdictions, the Court settled a longstanding issue for valuing closely held shares: whether open market discounts apply in forced minority-to-majority sales.
Due to the lack of any objective, market-provided stock price, properly valuing a minority shareholder’s interest in a closely held entity is a complex process typically involving expert appraisals and, all too often, litigation. To address this concern, well drafted shareholder agreements should include valuation methods that provide a framework to ensure the shares are valued fairly. However, a few characteristics presented by the nature of closely held entities have long been a point of contention for shareholders, appraisers, and attorneys. For example, whether to discount share value for a minority shareholder’s lack of a controlling interest in the entity and the lack of marketability, meaning a shareholder’s inability to sell the shares in any alternative market. These two discounts were specifically addressed in Hartman:
Blake Hartman was a founder and former president of BigInch Fabricators, a closely-held corporation out of Montezuma, Indiana with ten shareholders. When he was involuntary terminated from his position as a director and officer in March of 2018, Hartman owned 17.77% of the BigInch’s shares. Because Hartman’s shareholder agreement provided that he was entitled to the “appraised market value” of his shares, BigInch hired a valuation firm, which initially appraised his shares at $3,526,060. After including discounts for Hartman’s lack of a controlling interest in BigInch and his lack of marketability, the value of Hartman’s shares was reduced to $2,398,000.
Hartman filed suit to dispute this $1,128,060 reduction. While the trial court granted BigInch summary judgment and upheld the reduction, the Indiana Court of Appeals rejected the lower court’s analysis and held that the reductions were unlawful. The Court concluded that lack of control and lack of marketability are typically used in the context of open-market sales, but because BigInch was not a participant in the open market, the concepts were inapplicable. When evaluating lack of control, the Court reasoned that applying a discount to the shares of a minority owner would allow majority-shareholders to increase their control at a premium while forcing the selling-minority to incur an unwarranted reduction. Similarly, for lack of marketability, the Court concluded that discounts for lack of marketability are inappropriate as they would result in a windfall for majority stakeholders.
Hartman should increase the share value for minority stakeholders in closely held entities in Indiana by excluding discounts for lack of control and lack of marketability. Still, concise, effective shareholder agreements remain ever important. To discuss shareholder agreements, valuation of closely held entities, or any of your business’s legal needs, contact the trusted attorneys at Kahn, Dees, Donovan, & Kahn, LLP.