Fair Value or Fair Market Value?

Why the Difference Can Change a Wisconsin Business Buyout by Hundreds of Thousands—or Millions.

Most business-partner disputes eventually arrive at the same question:

What is the business worth—and how much should one owner receive to leave it?

The question may arise because one owner wants to retire. The partners may no longer agree on the direction of the company. A minority owner may believe that the controlling owners are withholding distributions, excluding that owner from management, or attempting to force an unfavorable exit. In other cases, the business is operating successfully, but the relationship among its owners has become impossible.

Whatever causes the separation, the parties frequently begin with the mistaken assumption that business value is simply a number. They expect an accountant or appraiser to review the financial statements, apply a formula, and announce the price.

In reality, the value of an ownership interest depends on much more than the company’s revenue or earnings. Before an appraiser can calculate the value, someone must answer several legal questions:

• What does the shareholder agreement or operating agreement require?
• What event triggered the buyout?
• What valuation date applies?
• Is the interest being valued as part of the entire business or as a stand-alone minority interest?
• Are discounts for lack of control or marketability permitted?
• Does Wisconsin statutory law apply?
• Has either side manipulated compensation, distributions, expenses, or financial projections in a way that affects the valuation?

One phrase in a contract—or one legal ruling about the correct valuation standard—can change the result dramatically.

That is why Wisconsin business owners facing a partner or shareholder buyout need to understand the difference between fair market value and fair value.

Fair Market Value: What Would a Hypothetical Buyer Pay?

Fair market value is the more familiar of the two concepts. The Internal Revenue Service generally describes it as the price at which property would change hands between a willing buyer and a willing seller, with neither side being required to act and both having reasonable knowledge of the relevant facts.

In the context of a privately owned business, the analysis asks what a hypothetical buyer would pay for the particular ownership interest under market conditions.

That distinction matters. A buyer considering 20% of a privately held company may not be willing to pay exactly 20% of the value of the entire company. The buyer may have no power to appoint management, control compensation, declare distributions, obtain a return on the investment, or force a sale of the business.

The buyer may also have no ready market in which to resell the interest.

Those concerns can produce two frequently disputed adjustments.

Discount for Lack of Control

A minority owner may be unable to direct the company’s operations or make important decisions. A valuation professional may therefore apply a discount to reflect the limited power associated with the interest.

The size and appropriateness of that discount depend on the actual rights attached to the interest. A 20% owner with significant voting, veto, information, or distribution rights may be situated very differently from a 20% owner with no meaningful ability to influence the company.

Discount for Lack of Marketability

An interest in a private corporation or limited liability company ordinarily cannot be sold as easily as publicly traded stock. The governing agreement may restrict transfers. Other owners may possess a right of first refusal. A buyer may face significant difficulty obtaining information, financing the acquisition, or eventually reselling the interest.

A marketability discount attempts to account for those limitations.

These discounts are not small technical details. Even relatively moderate discounts can change the value of an ownership interest by hundreds of thousands of dollars.

Fair Value: A Different Question for a Different Setting

“Fair value” sounds almost identical to “fair market value,” but the two terms are not interchangeable.

Fair value is often a legal standard tied to a particular statute, agreement, or judicial remedy. Rather than asking only what an outside buyer would pay for a minority interest, a fair-value analysis may focus on the owner’s proportionate interest in the company as a going concern.

Wisconsin’s Business Corporation Law uses fair value in certain statutory appraisal proceedings. For example, Wisconsin Stat. § 180.1302 gives shareholders dissenters’ rights in connection with specified corporate actions and permits qualifying shareholders to seek payment of the fair value of their shares. It does not, however, make fair value the automatic standard for every disagreement or buyout involving a Wisconsin business.

The distinction is important because a statutory appraisal is not necessarily comparable to an ordinary sale on the open market. The shareholder did not place the shares on the market and voluntarily accept the best available offer. The transaction may instead result from a merger, share exchange, or other corporate action approved over the shareholder’s objection.

The Wisconsin Supreme Court’s Decision in HMO-W

The Wisconsin Supreme Court addressed this issue in HMO-W Incorporated v. SSM Health Care System.

The case involved a shareholder exercising statutory dissenters’ rights after a corporate merger. The court concluded that a minority discount should not be used to determine the fair value of the dissenting shareholder’s shares. Applying such a discount in that setting would have reduced the shareholder’s recovery merely because the shareholder held a noncontrolling interest—the very circumstance for which the statutory appraisal remedy was intended to provide protection.

But HMO-W does not establish a universal rule that all business owners receive an undiscounted pro-rata share whenever a buyout is disputed.

The court expressly addressed a minority discount in a statutory dissenters’ rights proceeding. It did not decide that a lack-of-marketability discount is prohibited in every context. Later Wisconsin decisions have recognized that the applicability of discounts can depend on the source of the buyout obligation, the language of the agreement, the remedy being imposed, and the circumstances of the case.

That means the correct question is not simply:

“Is this fair value or fair market value?”

The more complete question is:

“What valuation standard applies to this particular transaction, under this agreement, involving this entity, based on this triggering event?”

What Could the Difference Mean in Dollars?

Consider a Wisconsin business with a total equity value of $10 million. One owner holds a 20% interest.

The owner’s proportionate share of the company’s equity value is $2 million.

Assume, for illustration, that a fair-market-value analysis applies:

Under an undiscounted pro-rata approach, the interest would be valued at $2 million. Under the discounted approach in this example, it would be valued at $1.28 million.

The difference is $720,000.

Neither number is automatically correct. The result depends on the governing legal standard, the contractual language, the facts surrounding the buyout, and the valuation evidence.

But the example demonstrates why the parties should determine the legal framework before accepting an appraisal methodology.

Start With the Shareholder Agreement or Operating Agreement

In many buyout disputes, the first and most important evidence is not a financial statement. It is the agreement among the owners.

A properly drafted agreement may answer questions such as:

• What events trigger a buyout?
• Is the purchase mandatory or optional?
• Who may purchase the departing owner’s interest?
• Does the agreement require fair value, fair market value, book value, or another formula?
• Does it permit or prohibit valuation discounts?
• What valuation date must be used?
• How will the appraiser be selected?
• What information must the company provide?
• Is the purchase price payable immediately or over time?
• Will deferred payments be secured?
• What interest rate applies?
• What happens when the parties’ appraisers disagree?

Unfortunately, many agreements use important valuation terms without defining them. Others contain formulas that made sense when the business was formed but produce an unexpected result years later.

Some agreements specify fair market value without addressing whether the appraiser should value the owner’s actual minority interest or the owner’s proportionate share of the entire company. Some require competing appraisals but provide no workable procedure when the appraisers reach dramatically different conclusions.

In Wisconsin LLC disputes, the operating agreement is especially important because it can govern many aspects of the company’s affairs and the relationships among its members. The analysis under Chapter 183 is not necessarily the same as the analysis governing a shareholder’s statutory rights under Chapter 180.

What Happens When the Agreement Does Not Provide a Clear Answer?

The absence of a clear buy-sell provision does not mean that fair value automatically applies.

The potential claims and remedies will depend on the circumstances. They may involve allegations of:

• Breach of contract;
• Breach of fiduciary duty;
• Shareholder oppression;
• Deadlock;
• Improper distributions;
• Misuse of company assets;
• Denial of access to company information;
• Self-dealing or related-party transactions;
• Manipulation of owner compensation;
• Wrongful termination of an owner-employee; or
• An attempted freeze-out or squeeze-out.

Wisconsin Stat. § 180.1430 permits a shareholder to seek judicial dissolution when those controlling a corporation have acted illegally, oppressively, or fraudulently. But dissolution is a distinct statutory remedy; the statute does not automatically convert every oppression claim into a mandatory undiscounted buyout.

Wisconsin courts may also be asked to interpret and enforce an existing buy-sell agreement. In Northern Air Services, Inc. v. Link, for example, a disputed business separation involved the enforcement of a contractual buy-sell procedure based on appraised fair market value. The case illustrates how the language of the parties’ agreement can determine both the process and the economic result.

The legal theory matters because it may determine not only whether a buyout can be ordered, but also how the interest will be valued.

The Valuation Standard Is Only the Beginning

Even after the parties identify the correct standard, they may still be millions of dollars apart.

Business valuation is based on assumptions. Those assumptions may concern:

Normalized Earnings

A closely held company may pay its owners above-market or below-market compensation. It may pay personal expenses, employ family members, own excess real estate, or incur one-time costs. Determining the company’s true ongoing earnings frequently requires adjustments.

Financial Projections

One side may rely heavily on recent growth and projected future earnings. The other may argue that growth is temporary, dependent on one customer, or unlikely to continue.

Valuation Date

A company’s value may change rapidly. The selection of a valuation date can become critical when the business gains or loses a major customer, experiences unusual growth, incurs new debt, or receives an acquisition offer.

Debt and Excess Cash

A business worth $10 million on an enterprise-value basis is not necessarily worth $10 million to its owners. Debt, excess cash, nonoperating assets, and other balance-sheet items can materially affect equity value.

Goodwill

The parties may disagree over whether the company’s earnings result from transferable business goodwill or from the personal reputation, relationships, or continued labor of one owner.

Discounts and Premiums

Even when discounts are legally permitted, the parties may dispute whether they are justified and how they should be measured. The mere fact that an appraiser applied a discount does not establish that the amount is correct.

Payment Terms

A promise to pay $2 million over ten years is not economically identical to receiving $2 million at closing. Interest, security, subordination, default rights, and the buyer’s ability to pay all affect the practical value of the deal.

Why the Company’s Regular Accountant May Not Be Enough

The company’s CPA may be an excellent financial professional and may possess substantial knowledge about the business. But the company’s accountant is not always independent, and ordinary accounting work is different from preparing and defending a litigation valuation.

A qualified valuation professional and experienced litigation counsel serve complementary roles.

The valuation professional analyzes the company’s finances and applies recognized valuation methodologies. Litigation counsel determines what the agreement and applicable law require, obtains the necessary financial information, develops the legal and evidentiary record, and tests the opposing expert’s assumptions.

A strong valuation case may require counsel to investigate:

• Whether financial information has been withheld;
• Whether revenue or expenses were shifted between periods;
• Whether controlling owners changed their compensation;
• Whether distributions were withheld to pressure a minority owner;
• Whether related entities received favorable treatment;
• Whether projections provided to the appraiser were reliable;
• Whether a prior appraisal, financing application, insurance submission, or acquisition offer contradicts the company’s current position; and
• Whether the opposing expert followed the correct legal standard.

These questions often need to be addressed before the parties commit themselves to a particular valuation process.

Early Decisions Can Shape the Entire Buyout

Owners sometimes assume they can agree on the methodology now and argue about the final number later. That can be a costly mistake.

A preliminary agreement, letter of intent, appraisal engagement, or casual email may later be used as evidence that the parties selected a valuation standard, accepted a valuation date, approved particular discounts, or waived objections to the process.

Before agreeing to an appraisal or proposed purchase price, an owner should understand:

1. What the governing documents require;
2. What legal claims or remedies may be available;
3. What information is needed to value the business accurately;
4. Whether the proposed appraiser is neutral and properly instructed; and
5. How the purchase price will actually be paid.

Once the wrong methodology becomes embedded in the negotiation, correcting it can become much more difficult.

Protecting the Value of What You Built

A business buyout is rarely just an accounting exercise. It is a legal dispute about ownership rights, contractual obligations, financial information, control, and the future of a company the parties may have spent decades building.

At Halling & Cayo, S.C., our business litigation attorneys help majority owners, minority shareholders, and LLC members evaluate disputed buyouts and ownership separations. We examine the governing documents, identify the applicable valuation framework, work with financial and valuation professionals, and develop a strategy suited to the client’s legal and business objectives.

Sometimes the best result is a negotiated separation that preserves the company and allows everyone to move forward. In other cases, obtaining a fair result requires formal discovery, expert testimony, motions before the court, or trial.

The important step is to evaluate the issue before signing an agreement, accepting an appraisal, or surrendering valuable ownership rights.

To discuss a Wisconsin shareholder, LLC-member, or business-partner buyout, contact Halling & Cayo, S.C. at 414-271-3400 or visit hallingcayo.com.

This article provides general information and is not legal advice. The applicable valuation standard and available remedies depend on the governing documents, type of entity, facts of the dispute, and current law.