We Disagree on What the Company Is Worth. How Valuation Disputes Are Decided

Why two honest experts can be millions apart

Owners assume a business has one value and someone is lying. Usually both numbers are defensible answers to different questions. One expert valued a one-third interest to a hypothetical outside buyer, applied a 30 percent discount for lack of control and another for lack of marketability, and capitalized earnings after the manager's actual salary. The other valued one-third of the whole company as a going concern, no discounts, with the manager's salary normalized to market. Same company, half the value apart. The dispute is about the rules, not the arithmetic, and the rules come from the agreement, the statute that applies to the proceeding, and Texas case law on discounts.

Where valuation disputes arise

• Buy-sell triggers: death, disability, divorce, termination of employment, deadlock, or a put or call in the agreement.
• Withdrawal or expulsion of a partner: the redemption price under section 152.602 is the fair value of the interest on the withdrawal date, reduced for wrongful withdrawal.
• An LLC withdrawal right granted by the agreement: fair value within a reasonable time (section 101.205).
• Dissenters' appraisal: an owner who votes against a merger, conversion or sale of substantially all assets may demand the fair value of his interest (section 10.354).
• Divorce: the community estate's interest must be valued for a just and right division.
• Damages: a fiduciary breach or freeze-out case where the loss is measured by what the interest would have been worth.
• Settlement: most owner disputes end in a buyout, and the price is the whole negotiation.

Standard of value: the question that decides the discount

'Fair market value' is the price a willing buyer would pay a willing seller, neither under compulsion, both informed. Because no outside buyer pays full pro rata value for a minority stake he cannot control or easily resell, fair market value of a minority interest ordinarily carries discounts for lack of control and lack of marketability. Those discounts commonly remove a quarter to a half of pro rata value.

'Fair value' is a legal term, and in Texas the statute defines it for appraisal proceedings. Section 10.362 provides that the fair value of a dissenting owner's interest is its value on the day before the corporate action, excluding any change caused by the action itself, computed by treating the entity as a going concern and without including any control premium, any minority ownership discount or any discount for lack of marketability. Section 10.362(c) adds that a fair value determination in an appraisal proceeding may not be used to fix the value of the same or another interest for any other purpose. So the no-discount rule is clear for appraisal cases and is not automatically imported into a buyout under an agreement or a withdrawal under chapter 152, where the document's own language and the parties' evidence decide whether discounts apply.

Buy-sell provisions and how courts treat them

A valuation clause in a company, partnership or shareholders' agreement is a contract term, and Texas courts enforce it as written. The common mechanisms:

• Fixed or agreed value, updated annually by the owners. Enforceable even when stale, which is why owners who stop updating it regret it.
• Formula: a multiple of trailing earnings or revenue, or adjusted book value. Disputes shift to the inputs: what counts as earnings, which add-backs are allowed.
• Appraiser mechanism: each side appoints an appraiser, and a third breaks the tie or the middle values are averaged. Courts generally hold the parties to the result absent fraud or a failure to follow the procedure.
• Shotgun: one owner names a price at which he will buy or sell, the other chooses. Self-policing, and enforceable.

Section 101.1115(b) and section 152.406 confirm that the Code does not impair an agreement to buy or sell an interest on death or divorce, and courts apply the same respect to other triggers. The enforcement side is in how a partner buyout is priced and enforced in Texas.

The three methods, and where they go wrong

Appraisers use three approaches and reconcile them. The income approach (discounted cash flow or capitalization of earnings) values the future cash the business will produce; it is the most common for an operating company and the most sensitive to assumptions about growth and risk. The market approach compares the company to sales of similar businesses or to public company multiples; its weakness is finding true comparables for a small Dallas company. The asset approach values what the company owns less what it owes; it fits holding companies and businesses worth more dead than alive, and it is the method a controlling owner prefers when the company's value is mostly goodwill he would rather not count.

Before any method is applied, the financials are normalized. This is where the real fight is. Owner compensation is adjusted to market, rent paid to an owner's entity is adjusted to market, personal expenses run through the company are added back, one-time gains and losses are removed, and related-party revenue is scrutinized. An expert who leaves the manager's $450,000 salary untouched produces a company worth far less than one who normalizes it to $150,000. If a self-dealing claim is pending in the same case, the normalization adjustments and the damages model are often the same numbers.

Example

Suppose three equal members of a Dallas marketing agency trigger the agreement's buyout clause when one leaves. The clause says the price is 'the fair market value of the departing Member's Interest as determined by an independent appraiser.' The departing member's expert values the company at $4.5 million using capitalization of normalized earnings and puts one-third at $1.5 million. The company's expert values the company at $3.6 million on a lower growth assumption, then applies a 25 percent discount for lack of control and a 20 percent discount for lack of marketability to the one-third interest, arriving at $720,000. The clause's wording, 'fair market value of the Member's Interest,' supports applying discounts to the interest rather than valuing a pro rata share of the whole, so the discount question is likely decided by the contract. The remaining gap, growth assumptions and normalization, is decided by which expert the court finds more reliable.

How a court chooses

Texas Rule of Evidence 702 requires expert testimony to be relevant and based on a reliable foundation, and a trial court acts as gatekeeper before the opinion reaches the fact finder. An expert whose method is accepted in the profession but whose inputs are unsupported, who ignores the agreement's definition of value, or who has not seen the underlying records, can be excluded or discounted. The fact finder then weighs credentials, methodology, independence and how each expert handled the normalization adjustments. Judges and juries tend to land between the numbers, but not reliably in the middle, and a party whose expert overreached is punished for it. When a case needs an expert and how one is chosen is covered in when a business case needs an expert witness.

Evidence that moves the number

• Five years of financial statements and tax returns, and the general ledger behind them.
• The agreement's valuation clause and any history of agreed values.
• Payroll records and market compensation data for the owner-operators.
• Related-party leases and contracts, with market comparables.
• Prior valuations: for a loan, an estate, a divorce, a buy-in. A company that was 'worth' $6 million when it borrowed is hard to describe as worth $2 million when it buys out a partner.
• Offers received, letters of intent, and broker opinions.

A forensic accountant often does the normalization work and the tracing of personal expenses that feeds the valuation expert; that role is described in how forensic accountants are used in business litigation.

What the dispute costs

Two valuation experts, their reports and depositions are a large share of the cost of any owner case, and the cost rises with the number of adjustments in dispute and the quality of the company's books. Owners can control some of it: agreeing on a single neutral appraiser, agreeing on the standard of value before the experts start, and producing complete records early. The money saved on experts usually exceeds whatever advantage either side imagined from ambiguity.

When to involve a litigator

Before you hire an appraiser. The appraiser needs instructions on the standard of value, the valuation date and the adjustments the agreement permits, and those are legal questions. An appraisal done to the wrong standard is wasted. Tina Wysk represents owners in buyout, withdrawal and valuation disputes in Dallas state and federal courts and in arbitration.