On October 6, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Zelouf Intl. Corp. v. Zelouf, 2014 NY Slip Op. 51462(U), deciding how a closely-held corporation should be valued.
In Zelouf Intl. Corp., after a drawn-out dispute over the rights of a 25% shareholder in a closely-held family textile business, culminating in a freeze-out merger, the parties commenced a BCL § 623 action to determine the value of the minority interest. The opinion as a whole presents a fascinating picture of waste of assets and minority oppression in a family business-the majority owner apparently paid his mother almost $1 million for providing him with “emotional support”-as well as discussing many factors to be considered in valuing a minority interest. This post will focus on one such issue, DLOM (“Discount for Lack Of Marketability”).
“The idea of a DLOM is that, since the company as a whole can be difficult to sell (e.g., buyers of closely-held companies in niche businesses are not as plentiful as buyers of publicly traded corporations), a frozen-out minority shareholder should recover less to reflect this fact.” In this case, although DLOMs are commonly applied, the parties’ joint valuation expert opined that one was inapplicable and the court agreed. Instead, the minority shareholder was awarded “the value received if the equity is held, not sold.”
The court based its finding upon the perks to the majority shareholder of owning the company, and the fact that, because the business is so dependent on personal relationships, “it seems unlikely that the company would or could ever actually be sold.”
While these facts, at first glance, might appear to militate in favor of applying a DLOM, the rationale for applying a DLOM breaks down when one considers that any liquidity risk associated with [the company] is more theoretical than real. No sale of the company has occurred since its 1984 founding. Nor is there any reason to think that [the majority shareholder] would walk away from a company providing him with millions of dollars in income, a similar, low interest loan facility, personal and family perks and control unless he eventually turns it over to other family members years down the road.
The company, without [the minority shareholder], will always remain under the control of the Zelouf family. This makes the company’s illiquidity irrelevant, mooting the concern for which a DLOM accounts.
The purpose of a DLOM is to account for “risk associated with the illiquidity of the shares.” Risk, of course, is a function of probability times the threatened harm. While the threat of harm here (a lower net purchase price due to illiquidity costs) is undisputed, the probability that such a threat will actually occur is negligible. Ergo, there is no risk that warrants a DLOM.
(emphasis in the original).