Canada: The Valuation Of A 50% Shareholding In A Closely Held Corporation

Last Updated: September 15 2014
Article by Richard M. Wise

A shareholder owning 50 percent of the voting shares of a private corporation is neither a controlling shareholder nor a minority shareholder (in the true sense), absent any agreements, resolutions, articles, or bylaws that would otherwise provide de facto or de jure control. Although such shareholding lacks control and cannot elect the board, formulate policy, declare dividends, and make other corporate decisions — such as in the case of a 50 percent plus 1 voting position (giving the holder de jure control), it nevertheless has blocking power.

Consequently, absent a shareholders' agreement, discounts are often applied to the 50 percent pro-rata fair market value of the shareholding to reflect both lack of control and lack of marketability/illiquidity. The size of the minority discount and of the marketability discount will consider and reflect the following factors, as appropriate in the specific circumstances:

  • the terms of any shareholders' agreement, including the buy-sell covenant;
  • the dispersion of the remaining shareholdings;
  • the relationship subsisting between the 50 percent shareholder and the remaining shareholders;
  • the relationships subsisting among the remaining shareholders and whether there are any voting blocks;
  • the degree of harmony among the shareholders;
  • size of each of the other shareholdings (e.g., 10 other shareholders each owning 5 percent of the shares as opposed to one other shareholder owning 50 percent);
  • the blocking (veto) power of the 50 percent shareholding over corporate decisions;
  • the ability to block a fundamental corporate change (liquidation, recapitalization, sale of all or substantially all of the company's assets, etc.), which requires two-thirds of the votes to approve a special resolution of the shareholders;
  • the inability to proactively cause a corporate action to be taken;
  • the extent to which the 50 percent shareholder has "operating" control;
  • whether the 50 percent shareholder is a key person;
  • whether the 50 percent shareholder is a significant creditor of the company;
  • existence of call options, warrants, or rights;
  • the expected length and/or uncertainty of the anticipated holding period;
  • whether a court might view the shareholder relationship as joint tenancy, with the possibility of ordering a liquidation or corporate dissolution;
  • whether there is an historical track record of dividends and/or other distributions; and if so, reasonable expectations that such payments would continue to be made; and
  • the likelihood and timing of a liquidity event occurring.

The potential to acquire other share blocks may influence value. Acquisition of, say, a 17 percent voting block by the 50 percent shareholder may enable the passage of a special resolution requiring 66-2/3 percent of the votes— for example, for liquidation, recapitalization, or a sale of substantially all of the corporation's assets.

Generally, the fair market value of a 50 percent voting interest lies between the value of a controlling interest and the value of a minority interest that can block a special resolution. There are no empirical supporting data directly on point regarding either (a) discounts from the control value or (b) premiums over the minority value in estimating the fair market value of a 50 percent voting position in the company.

The challenges in valuing a 50 percent shareholding go back many years. The courts have considered these factors in (a) bankruptcy, (b) gift, estate and income tax, (c) marital dissolution, and (d) minority shareholder suits. The discounts often ranged between 25 percent and 35 percent.

In his 1967 paper, "The Innocent Shareholder and the Value of His Shares," T. A. Hamilton Baynes, a wellknown British author on business valuation, discussed the situation of a 50 percent shareholder:

Where there are two shareholders, each of whom owns 50% of the shares, the valuation of the shares of either presents great difficulties. It is true that in the normal world no one would purchase a 50% holding without a condition that a seat on the Board would be forthcoming. In the 'dim world peopled by the indeterminate spirits of fictitious or unborn sales' there would be no certainty whatever that a purchaser could make such a bargain. In fact, the only way of valuing the shares would be to assume that every obstacle would be put in the way of the intruder becoming a Director. There would be no opportunity of acquiring the one share to give him control. In all, it would be a most unattractive proposition and the purchaser would have to rely on future dividends or the future liquidation. This actual position was discussed by Rowlatt, J. [in Re Courthope, [1928], 7 A.T.C. 538].1

In Obermer v. U.S., 238 F. Supp. 29, (U.S. District Court, Hawaii, 1964), the deceased and his wife each owned half of the outstanding shares of a family investment corporation. Tavares, D.J., stated at page 34:

IV. The so-called mythical buyer would also only obtain 50 percent control of the corporation, the other 50 percent being held by Mrs. Obermer. This divided control did not result in any difficulty so long as Mr. and Mrs. Obermer were living and not estranged. However, the injection of a new owner of Mr. Obermer's half of the stock would certainly complicate matters. Mrs. Obermer certainly could block liquidation of the corporation since the New York law required 66-2/3 percent stock ownership to approve of any liquidation, a liquidation would seem highly improbable on her part because of the large capital gains tax which would have to be paid, amounting to some $145,000.00. Taking into consideration Mrs. Obermer's good health and life expectancy at age 63, according to the testimony, a mythical purchaser would certainly have to wait a long time for her death and possible liquidation of her stocks at that time. Thus he would be tied down to having to get along with the income producing ability of the corporation, at least until and unless some other arrangement could be reached with the other stockholder, or she died.

V. The Court also believes that the probable special selling expense of this unlisted stock would also have some effect on the valuation of this stock by a mythical buyer.

A discount of 33-1/3 percent from pro rata value was applied by the court. Some subsequent U.S. cases addressing the valuation of a 50 percent shareholding are:

  • Estate of Fleming v. Commissioner, T.C. Memo 1997-484, 74 T.C.M. (CCH) 1049
  • Estate of Auker v. Commissioner, T.C. Memo 1998-185, 75 T.C.M. (CCH) 2321
  • Dahill v. Dahill, 1998 Conn. Super. LEXIS 2524
  • Lakin v. Lakin, 1999 Conn. Super. LEXIS 3475
  • Barone v. Barone, 2000 Ohio App. LEXIS 3911
  • In Re Marriage of Franzen, 2003 WI App. 42, 658 N.W. 2d 87;
  • Devivo v. Devivo, 2001 Conn. Super. LEXIS 1285

In England, the British House of Lords decision in Ebrahimi v. Westbourne Galleries Ltd., [1973] A.C. 360 (H.L.) went much further: the court equated a closely held corporation to a partnership and ordered dissolution at the insistence of a minority shareholder who had been excluded by the majority from participation in the operations (an alternative to a buy-back of an oppressed shareholder's stock under the applicable oppression remedy provisions of company law).2

In Re Bird Precision Bellows Ltd. [1986] 2 WLR 158, the family law court found the business had the character of a quasi partnership, and applied a prorata valuation.

The Tax Court of Canada in Zeller Estate v. Her Majesty The Queen, 2008 TCC 426 (CanLII), applied a 10 percent discount for lack of control and a 7 percent discount for lack of marketability to a 50 percent shareholding in a closely held family corporation. Justice Campbell stated that:

owning a 50 percent interest in a company is clearly not one and the same as ownership of a 51 percent interest. ...logically some discount should be applied to an owner of a 50 percent interest, even though it would be less than the discount applicable to a minority shareholder of less than 50 percent.

(The Court had accepted a 15 percent minority discount and a 7 percent marketability discount for a one-third shareholding.)

The American Society of Appraisers, through its Business Valuation Committee, has recognized the special nature of a 50 percent ownership interest in Procedural Guideline PG- 2, "Valuation of Partial Ownership Interests" (2009):

II. General principles

A. Partial ownership interests are interests of an enterprise or an asset of less than 100 percent. Partial ownership interests may exist in various business entities and assets such as corporations, limited liability companies, partnerships, and as direct fractional ownership of certain tangible and intangible assets. B. Partial ownership interests comprise a spectrum of positions, from nearly total control (e.g., a 95 percent stock ownership position in a corporation, or the sole general partner of a limited partnership) to almost complete lack of control (e.g., a small block of non-voting corporate stock).

C. It is not possible to categorize partial interests in simple terms.

1. Generally, a partial ownership position in an entity or asset that is less than 50 percent may be classified as a noncontrolling or minority interest. Similarly, an interest of greater than 50 percent often confers control. An exact 50 percent interest may have both control characteristics (such as blocking power) and lack of control characteristics (such as inability to proactively cause an action to be taken). (emphasis added)

2. The degree of ownership does not always indicate the degree of control.

In closing, when valuing a 50 percent shareholding, the valuator must be especially mindful of the relevant provisions of any shareholders' agreement,3 the company's Articles of Association, the particular jurisdiction's applicable legal statutes and the related case law, as well as how any options, rights, warrants, or convertible securities might impact the "balance of power" and, of course, whether a liquidity event such as dissolution or an outright sale of the company might be on the horizon.

Footnotes

1 Accountancy, August 1967, p. 522.

2 Another interesting decision of the Lords of Appeal in Ordinary (Law Lords) was in Short v. Treasury Commissioners, [1948] A.C. 534 (H.L.).

3 See, for example, Richard M. Wise, "Shareholders' Agreements," Proceedings of Sixth Joint Business Valuation Conference, The Canadian Institute of Chartered Business Valuators and the American Society of Appraisers (Toronto: October 19-20, 2006).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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