Agreements Create Marketability Discount in Shareholder Dispute

In September 2014, the New York Supreme Court issued its decision concerning the valuation of the country’s largest privately held beverage company.  John Ferolito and related parties owned 50% of Arizona Iced Tea. Domenick Vultaggio owned the other half.

By any measure, Arizona was an extremely successful company.  Founded in 1992, the two owners began to have problems in 1994. By the late 1990’s, the two agreed that, in order to ensure the continuity of the company, there could be only one captain of the ship, giving Vultaggio management control. They also entered into an “Owners Agreement,” which, in effect, prevented one partner from transferring his shares in Arizona to persons and entities not specified in the agreement without the consent of the other partner.

Since 2005, Tata, the second largest tea manufacturer in the world, frequently expressed an interest in acquiring all or part of Arizona and estimated its value to be as high as $4.5 billion. Nestle, expressed an interest in acquiring Ferolito’s interest for $1.45 billion provided that (a) due diligence was conducted, (b) Vultaggio’s shares were eventually acquired, and (c) Nestle, along with Ferolito and Vultaggio, arrived at a mutually agreeable path for Nestle to control Arizona.  Neither of these proposals went very far and Ferolito sued for dissolution of the company.

New York law provides that the respondent in a dissolution proceeding may purchase the shares of the petitioner “at their fair value.” The statute neither defines “fair value” nor provides criteria for the determination of “fair value.” The case law does, however, offer such guidance: “[I]n fixing fair value, courts should determine the minority shareholder’s proportionate interest in the going concern value of the corporation as a whole, that is, what a willing purchaser, in an arm’s length transaction, would offer for the corporation as an operating business.” Furthermore, “[B]ecause closely held corporations by their nature contradict the concept of a market value, market value may be of little or no significance.” Rather, investment value is often the appropriate valuation methodology. Such a methodology may incorporate a discount for the company’s lack of marketability which recognizes that a potential investor would pay less for shares in a close corporation because they could not readily be liquidated for cash.

Vultaggio claimed that a 35% lack of marketability discount was appropriate while Ferolito argued that there should be no discount. In Zelouf International Corp. v. Zelouf, the Court declined to impose a discount for lack of marketability concluding that any liquidity risk associated with the company was more theoretical than real. By contrast, the failed negotiations of Tata and Nestle support the view that a discount was appropriate. The fact that Arizona did not have audited financial statements for many years prior to the valuation date, the extensive litigation between the shareholders, the uncertainty about the Company’s S corporation status, and the transfer restrictions in the Owners Agreement all provide a basis for the discount. Since these factors are not insurmountable, the Court applied a lesser discount of 25%.

Whether a discount should be applied in the valuation of any company depends on the facts and circumstances. Contact Mike Stover of Brady Ware at mstover@bradyware.com or 937-913-2507 if you have a question concerning the value of a company or whether certain discounts to the value are applicable.


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