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Marketability and Minority Discounts in South Carolina Courts
If you’re a part owner of a closely held corporation, it can be challenging to determine the dollar value of your interest in it. Not only do closely held corporations not make their finances public, making it difficult to know the company’s value as a whole, but your interest in it could be subject to discounts – like a marketability discount or a minority discount – that reduce the value to less than you might expect.
A case heard by the South Carolina Supreme Court, Clark v Clark, discussed both marketability discounts and minority discounts (also called lack of control discounts) in the context of a divorce, illuminating how SC courts consider and evaluate such discounts.
First let’s look at the methods used to determine the value of closely held corporations, then what the discounts are, then the case itself.
Methods to determine value a closely held company
The value of a closely held corporation and an interest in it can be determined by a few different methods.
Income approach. This method examines the company’s past earnings in order to project future earnings. This approach is popular because it looks at something that’s of interest to the potential buyer: how much money they can expect to see from their investment. However, it ultimately relies on making predictions about the future which no one can really know, which is the primary disadvantage.
Value, asset, or book approach. This method adds together the value of assets (minus depreciation) and then subtracts liabilities. It’s simple and straightforward and doesn’t require any guessing, but it fails to take many factors into consideration, such as a company’s brand recognition, customer goodwill, and other intangible but important factors.
Market approach. This method compares the private company in question to public companies that are similar in size, industry, and so on to come to a value. This approach works well when there are public companies that are similar enough to the closely held corporation to make a fair comparison, but it’s a poor choice when there aren’t.
Discounts on Interest in Closely Held Corporation
Two common discounts that can be applied to an owner’s partial interest in a closely held business are the lack of marketability discount (also called, simply, the marketability discount) and the lack of lack of control discount (also called the minority discount).
Marketability discount. This discount may be applied since there’s typically a significantly smaller market of potential buyers for privately held stock compared to publicly held stock. The transaction usually takes longer and involves higher transaction costs, too.
Lack of control/minority discount. Similarly, this discount recognizes that being a partial owner without controlling interest in a company is much less appealing than owning a controlling share. (In fact, control is so important in closely held businesses that controlling interests can sell for more than face value due to what’s called “premium for control.”)
Background of Clark v Clark
In the case at hand, Clark v Clark, the central issue is the value of the minority interest held by Patricia Clark in her husband George Clark’s family business.
The two married in 1987 and filed for divorce in 2012. At the time of the divorce, George owned 75% of the family business his father founded in the late 1980s, Pure Country, Inc., which manufactures and sells custom tapestry, blankets, afghans, and so forth. George had been 100% owner after his father died but then transferred 25% interest to Patricia in 2009 when she approached him about getting equity in the company. The stock agreement for the transfer restricted her ability to sell her interest “to the business, other shareholders, or immediate family members.”
Putting a value on Patricia’s equity
In an 8-day bench trial, George and Patricia called separate experts to testify as to the value of Patricia’s 25% interest in Pure Country, Inc. George’s expert, Catherine Stoddard, used three different approaches to determine the value and explained her reasoning to the court.
- The income approach led to an initial value of Patricia’s 25% at $116,365. Stoddard then applied a 35% marketability discount to account for the issues discussed above as well as the specific stock agreement in this situation that limited Patricia’s ability to sell her interest to select buyers.
- The asset approach valued the entire company at $736,000 and Patricia’s share, with a marketability discount and a lack of control discount applied, at $83,725.
- The market approach led to a value of $65,430 for Patricia’s 25% interest.
Stoddard determined that $75,000 was the appropriate value. This included both discounts.
Patricia’s expert, Marcus Hodge, came to a different conclusion. He compared the company to other companies he believed were comparable – also in the mill industry in North Carolina, as Pure Country, Inc. was – but didn’t show how they were indeed comparable in terms of size, scope, and lines of manufacturing. He valued the entire company at $1.8 million and applied a 26% marketability discount, but later said it should not be discounted. Hodge did not apply a minority discount.
The family court debated whether or not discounts should be applied since the business was not actually going to be sold. Ultimately, it found Stoddard to be more credible and agreed that Patricia’s 25% interest was worth $75,000.
The SC Court of Appeals heard the case and affirmed the family court’s decision to apply a lack of control discount. However, it rejected the marketability discount, in part because there was no evidence that George planned to sell the company, and it wasn’t appropriate to engage in the “fiction” that the business was going to be sold.
The Supreme Court hears the case
Both parties appealed, and the Supreme Court of South Carolina heard the case in December 2019.
The supreme court agreed with the family court that a marketability discount did apply. Whether or not the company is actually going to be sold, “a party’s interest in a closely held corporation is valued according to its fair market value.” That amount is what a willing buyer would pay a willing seller in a sale. It’s not required that be business will actually be put up for sale, but that fiction is a helpful way to determine the value of a company or interest in it. In a footnote in the opinion, the court states, “South Carolina embraces fair market value, which is not controlled by an owner’s intent—rather it reflects the time it would take to sell the asset in question.”
However, it doesn’t mean that a marketability discount need apply in every situation. South Carolina has recognized that its applicability can and should be determined on a case-by-case basis. The supreme court believes the best approach is to allow the family court or trial court judges the discretion to apply them depending on the facts of the case before them. In this case, the supreme court agreed with the family court that George’s expert, Catherine Stoddard, was more credible.
The supreme court also agreed with the family court that a lack of control discount applies here. Patricia argued that because her 25% interest would be going to George, making him 100% owner of the company, the lack of control discount should not apply. But the supreme court stated that “the minority status certainly affects an asset’s fair market value” so it’s appropriate for courts to consider applying them.
The supreme court ultimately found that the appropriate value of Patricia’s 25% interest was $86,226.
Three justices agreed with the majority opinion, while two disagreed in an interesting dissent. They believed that neither discount should have been applied in this case. The similarities to a previous case, Moore v Moore – in which the share in question would go to the individual who owns the rest of the company, and there’s no intent to sell – are strong enough that it makes sense to follow the conclusions of that case, in which neither discount was applied. Since Patricia’s 25% would go to George, who owns the other 75%, there is no real, actual possible devaluation of her interest. Therefore, it’s not appropriate to apply either discount in this case.
Business Advice from an Experienced Business Attorney
For business legal advice on protecting your majority or minority shareholder status in a closely held corporation, work with an experienced business attorney like Gem McDowell. Gem has over 30 years of experience helping people start, grow, and protect their businesses. He and his associates at the Gem McDowell Law Group can help you, too. Call the Mount Pleasant office today at 843-284-1021 to schedule a free consultation.