In my view the biggest problem in shareholder disputes is ‘valuation’. Valuation is a dangerous business. Every economist knows there is only one ‘value’. That is the market value. There is no other valid indicator of value. Every other attempt at valuing shares is a crude attempt to proxy market value.
Valuation is done by lawyers who engage ‘business valuators’. They are generally accountants and as such their valuation is not strictly market valuation but a combination of accounting metrics meant to proxy market value.
There is a good reason why, in family law, the courts are supposed to say, that if the parties cannot agree on the value, the house will be sold. This is the true and only valid insurance that each spouse is getting his or her real value. Lawyers are generally insensitive to the potentially vast difference in the two outcomes. This is demonstrated by the fact that so many family law judges do not see the difference between ordering one party to pay the other a forced ‘valuation’ and ordering a matrimonial home sold to determine the actual and true value. Many judges are influenced by the ‘sentimental’ value of the home or the ‘need’ not to disrupt the children’s environment.
Because there is no ready market for corporate shares (unlike matrimonial homes), courts therefore regularly engage in ‘valuation’ exercises. The only valid valuation of a share is as a multiple of its true earning power. Remember that Benjamin Graham had a 10x earnings rule governing his stock market purchases. This applied to mature, liquid shares. In Ottawa, dealing with small risky private companies, shares can sell for a minimum of 2x annual net earnings and sometimes up to 4x earnings.
Goldstein J. of the Superior Court of Ontario, in Prolink Broker Network Inc. v. Jaitley (2018) 145 O.R. (3d) 277), as usual, had to decided what parts of each expert valuation to accept. The plaintiff said that gross income was $162k of which maintainable earnings were $41k which the plaintiff then wanted to multiply by 10x to get the value of shares. The defendant (whose job it was to minimize value) said the same gross revenue could only maintain $25k which should then be multiplied 4x.
Goldstein did what judges do: he split the difference and decided effectively upon 25k as maintainable and multiplied it by 6.5x.
There are established, deep liquid Canadian stock market companies trading at lower than 6.5x earnings and paying 6% dividends (example: BTB; GRT, NXR, NVU). This suggests that Goldstein’s multiple of 6.5 might be too high. If the earning-power of this firm is really stable the multiple should be even higher. If there is risk as Goldstein noted, it should be lower.
The bigger problem with the Superior Court of Ontario ‘valuation’ is that, in this case, the valuation was 2009. We have 10 more years of earnings (2009-2018) to actually see whether the 2009 expert-valuations were remotely accurate. One of the experts was rational enough to say that 2009 numbers had to be ‘normalized’. This is the superior court’s somewhat grudging acknowledgement that these valuation exercises are wrought with danger.
