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Balsamides v. Perle

313 N.J. Super. 7, 712 A.2d 673 (App. Div. 1998)

CORPORATIONS; SHAREHOLDERS; VALUATION—In valuing a corporation for shareholder buy-out purposes, a court can combine the approaches taken by opposing experts. No marketability discount is to be applied when one 50% shareholder buys out the other 50% shareholder.

In this case involving the value of a closely held corporation, one shareholder’s expert valued the corporation by the excess earnings approach authorized by Revenue Ruling 68-609. He explained that he calculated a percentage return on the average annual value of the business’ tangible assets using the immediate five years prior to the valuation date. That amount was deducted from the average earnings of the business for the same time period, and the resulting amount (the average annual earnings from the intangible assets of the business) was capitalized at a 30% rate. He then applied a 35% marketability discount.

The other shareholder’s expert disagreed with the resulting valuation. He objected to the eleven percent rate used by the plaintiff’s expert to determine the return on net tangible assets and to the thirty percent capitalization rate because of the company’s significant positive growth. He also disagreed with the thirty-five percent marketability discount, testifying that a nominal marketability discount should be used instead. He concluded that the value of the company was about twice that reached by the first expert. Lastly, he used only the prior three years in his analysis. The lower court accepted the valuation of the first expert.

On appeal, the Appellate Division noted that it is difficult to attach value to a close corporation. The Court pointed out that even the IRS cautions its own employees with respect to the excess earnings approach used by the first expert, stating that the rates of return to be used could be arbitrary and unsupported by the evidence. Apparently, the lower court chose the first expert’s approach in part because it was not satisfied with the three-year approach used by the second expert. The Court held that the lower court was not restricted to adopting one approach or the other, but could have selected the best of each and applied a five-year timetable to the second expert’s approach.

The Court also held that the thirty-five percent marketability discount is inapplicable since the stock was to be sold to another stockholder rather than the public at large. It cited a California case for support, but noted that all jurisdictions were not in agreement on this point. The Court also noted that the valuation provision of the Business Corporation Act does not warrant a departure from the sensible approach of denying a discount for lack of marketability when one owner transfers his or her interests to another owner, who in turn becomes the corporation’s sole shareholder. The statute directs the price of shares “shall be their fair value as of the date of commencement of the action or such earlier or later date deemed equitable by the court, plus or minus any adjustments deemed equitable by the Court if the action was brought whole or in part under paragraph 14A:12-7 (1)(C).” The Court found that it would be neither “fair” nor “equitable” for the remaining shareholder to obtain the selling shareholder’s interest at a discount. In its view, it serves neither fairness nor equity for a fifty percent shareholder to receive less than half of the corporation’s value.


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