When a shareholder in a private company leaves, falls out with the others or simply wants to sell, the hardest question is usually the price. There is no quoted share price to look at, the shares are often subject to transfer restrictions, and the buyer and seller want opposite answers.
The best time to settle how the price will be worked out is when the shareholders' agreement or articles are drafted, before anyone knows which side of the transaction they'll end up on.
Why share valuation matters
If your documents say nothing, a transfer between shareholders is just a negotiation, and a shareholder who feels squeezed out may turn to the court. If they set out a method, the price follows from the method and the argument moves on to how it is applied: which accounts, which adjustments, which valuation date. Most valuation disputes are about those details, so the drafting matters more than the headline method.
Tax matters too. Where shares pass between connected people, or otherwise than by a bargain at arm's length, HMRC can substitute market value for capital gains tax purposes, whatever price was actually paid. And where someone acquires shares by reason of their employment or directorship for less than market value, there can be an income tax charge under the employment-related securities rules. Take tax advice before agreeing a price that departs from market value.
The main valuation methods
Earnings multiple
The most common approach for a profitable trading company is to apply a multiple to its maintainable earnings, often EBITDA (earnings before interest, tax, depreciation and amortisation) adjusted for one-off items and for directors' pay that is above or below a market rate. Say adjusted EBITDA is £200,000 and the multiple is 5. That gives an enterprise value of £1 million, which you then adjust for cash and debt to arrive at the value of the shares.
The multiple depends on the sector, the size of the business, its growth and risk, and how dependent it is on the people who own it. It is where most of the argument happens. A multiple written into an agreement years ago can end up badly out of date, so if you fix one, consider building in a periodic review.
Revenue multiple
A revenue multiple is used for early-stage or loss-making businesses where earnings don't mean much, and in some sectors where recurring revenue is the key measure. It ignores profitability, so it can flatter a business that has grown by spending heavily.
Discounted cash flow
A discounted cash flow valuation forecasts the business's future cash flows and discounts them back to a present value at a rate that reflects the risk. In theory it is the most complete method. In practice the answer is very sensitive to the forecasts and the discount rate, which makes it easy to argue about in a dispute between shareholders.
Net assets
This is assets less liabilities, taken from the latest balance sheet or with assets revalued. It suits property and investment companies, and it can act as a floor for a trading company. For a trading business whose value lies in its customers, staff and know-how rather than its balance sheet, it usually produces a figure well below what a buyer would pay.
Comparable transactions
What similar businesses have sold for is a useful cross-check, but reliable information on private company sales is hard to find and no two businesses are quite alike.
An independent valuer will often use more than one method and weigh the results. A shareholders' agreement doesn't usually need to prescribe the method in detail. It can leave that to the valuer, as long as it deals with the questions below.
Market value, fair value and minority discounts
The biggest question in most share valuation clauses is whether the price is a proportionate share of the value of the whole company, or what someone would actually pay for that particular block of shares.
Market value, in the usual sense, is the price a willing buyer would pay a willing seller for the shares being sold. A minority holding is usually worth less per share than a controlling one, because the buyer can't control the board, dividends or a sale, and there is no ready market for the shares. So a market value approach normally applies a minority discount, and its size depends on the size of the stake and the rights attached to it. Voting thresholds matter here: more than 50% controls ordinary resolutions, 75% controls special resolutions, and more than 25% is enough to block a special resolution.
“Fair value” has no fixed meaning in this context. It means whatever the articles or the agreement say it means. Many clauses define it as the value of the whole company divided pro rata among the shares, with no discount for a minority holding and no premium for control. If the clause doesn't say whether a discount applies, the valuer has to decide, and that is a common source of dispute. Say expressly whether a minority discount is to be applied, and whether the valuer should take account of the restrictions on transfer in the articles.
Where the court orders a buyout on an unfair prejudice petition under section 994 of the Companies Act 2006, it decides the basis of valuation itself. In companies run on the basis of mutual trust and an understanding that all the shareholders would be involved, often described as quasi-partnerships, courts have commonly valued a minority holding pro rata without a discount. The court has a wide discretion, though, and the result depends on the facts.
Good leaver and bad leaver pricing
Where shareholders also work in the business, the articles often say that a shareholder who leaves must transfer their shares, at a price that depends on why they left. A good leaver typically receives fair value or market value. A bad leaver typically receives the lower of fair value and what they paid for the shares, or sometimes only the nominal value.
The definitions matter more than the prices. Check who counts as a bad leaver. Dismissal for gross misconduct and breach of restrictive covenants are common triggers, but some definitions catch anyone who resigns within a set period, or anyone who is dismissed for any reason. Some agreements have an intermediate category, or reduce the bad leaver element over time. Check too whether the price is fixed at the date of leaving or at a later valuation date, and what happens if the leaver disputes the reason they left.
Leaver provisions agreed between shareholders are generally enforced as written. Departing shareholders sometimes argue that a bad leaver price is an unenforceable penalty, but whether that argument has any force depends heavily on how the clause is drafted and its commercial purpose, and neither side should rely on it.
What happens when shareholders disagree on valuation?
The usual process is a short period for the parties to agree a price, after which an independent accountant or valuer is appointed to decide it. The clause should say who appoints the valuer if the parties can't agree (often the head of a named professional body), that the valuer acts as an expert and not as an arbitrator, what information the valuer receives and whether the parties can make submissions, who pays the valuer's fees, and the valuation date.
An expert's decision is usually stated to be final and binding except in the case of fraud or manifest error, which leaves very little room to challenge it afterwards. That makes it worth getting the instructions right in the drafting.
Shotgun or “Russian roulette” clauses sidestep valuation altogether. One shareholder names a price, and the other must either buy at that price or sell at it. They encourage a fair offer, but they favour whoever finds it easier to raise the money.
Checking your own documents
Read your articles and shareholders' agreement together and check that they say the same thing about how the price is set, whether a minority discount applies, who decides if you can't agree, and who counts as a good or bad leaver. You can upload your shareholders' agreement to QuickLegalCheck for a review of the transfer and valuation provisions, or see a sample report first.
Related: what the shareholders’ agreement review covers, and a complete sample report.