When appointed to value a business in the context of a shareholder dispute or divorce, we are often told the percentage proportion of the relevant interest, for example:
- the client ‘only’ has a 16% shareholding in a company and, therefore, has a minority shareholding; or
- the client has a 50% interest and, therefore, while still not a majority, holds a significant interest.
However, further investigations may identify that in fact, despite holding only 16% of the total share capital, the client holds 100% of all voting shares and so has a greater level of control than initially anticipated. Or we discover that our 50% shareholder owns shares with no voting rights at all.
Although initial expectations are that a share would carry equal dividend rights and value in proportion to the overall number of shares, this is not always the case. The value of a shareholding isn’t just a function of the proportion of the business held, but the rights attributed to that shareholding, whether through voting rights or predetermined rights to value.
Voting rights
Voting rights impact whether or not a shareholder has the opportunity to maximise returns from a company. Whilst the directors of a company control its day-to-day operations, dividends must be approved by shareholders controlling more than 50% of the voting rights. Shares with voting rights attached therefore have the ability to control the resources of a company whereas non-voting shares have no control. This difference in control is usually reflected by the application of a discount to the value of non-voting shares in comparison to the value of voting shares.
Rights to value
In our experience, the allocation of the value of a company between its shareholders is either straight forward (for example, a pro-rata share adjusted to take into account voting rights and the size of the overall holding) or complex.
Waterfalls – but not of the picturesque kind
We often see articles of association or shareholders’ agreements detailing complicated rights attributed to shares after, for example, private equity investment in owner managed businesses. These commonly contain ‘waterfall’ provisions which control the allocation of value to different classes of shares – usually the return due to each class of shares will ‘cascade’ down different share classes as the value of the company increases, usually as increasing thresholds are met.
So ‘A’ shares might see a return when the value of the company reaches £5 million, but ‘B’ shareholders only see a return when the company value climbs above £10 million – a valuation of those ‘B’ shares will need to reflect the fact that the threshold for a return to that shareholder is much higher and therefore less likely to be achieved.
In any situation, but especially in the context of a dispute, we must bear in mind that these waterfall arrangements can mean the value of a shareholding is not just a pro-rated proportion of total value. Most frequently the valuation is lower than would be expected (due to voting or capital restrictions attached to the shares), but it can be higher.
In summary
The rights attributed to the shares really do matter and can significantly impact the value of a shareholder’s interest in a company. So when a client says they ‘only’ have a 16% shareholding or they own 50% of the shares, it’s worth spending a moment checking exactly which shares they are talking about.
