Many developed countries (including Canada, New Zealand and all the states in the United States of America) have adopted the remedy of dissenting shareholders’ appraisal rights. The remedy is an innovation to the South African company law landscape and was recently provided for in Section 164 of the Companies Act No. 71 of 2008 (“Act”).
In short, Section 164 of the Act allows a dissenting shareholder to elect to be bought out by the company in which he holds shares, for the fair value of his shares. The dissenting shareholder will only be able to do so when the majority of the shareholders of the company pass a special resolution to:
- dispose of all or the greater part of the company’s assets or undertaking;
- enter into an amalgamation or merger;
- implement a scheme of arrangement; or
- amend its Memorandum of Incorporation by altering the terms of any class of shares in any manner materially adverse to the rights or interests of the relevant shareholders.
The Act does not however specify the means by which ‘fair value’ is to be determined, and in practice such determination is initially left to the company’s directors who are required to also provide a statement showing how that value was calculated. If a shareholder considers the company’s valuation inadequate, or if the company fails to make an offer as required by the Act, the shareholder can then apply for a court’s valuation. Such valuation can either be performed by the court itself or with the assistance of professional appraisers.
Currently there has been no reported case law on section 164 of the Act which dictates a set rule for the calculation of ‘fair value’.
The failure of the Act and hesitancy of the South African courts to provide for this valuation is a critical flaw of the remedy.
Historically, Canada and New Zealand have followed the decisions of the Delaware court when determining the ‘fair value’ of minority shares. It seems only appropriate for the rest of this article to therefore focus on the examination of the valuation methods adopted by the Delaware court, namely:
- the Companies Acquisition Method which is a valuation approach where the company’s potential sale price is derived by identifying similar companies in similar transactions;
- the Comparable Company Approach which is a valuation approach which compares two similar companies by identifying comparative companies based on the products of the companies, capital structure, personnel, earnings, growth prospects and risk. And then deriving financial measures that can be used to compute the value of the company i.e. The Earnings Before Interest and Tax financial indicator;
- the Delaware Block Method which is a valuation which combines three means of calculation, namely the asset value approach (here the court sums up the aggregate of the assets to get the actual valuation of the company), the market value approach (here the court calculates what the value of the company is) and the earning approach (here the court views the earnings of the company and capital as a whole, before any deductible taxes). Once the value of the company has been determined using each of the aforementioned methods, the court determines the percentage weight to grant each method in calculating the final value and then the court calculates the weighted average of these three valuations; and
- the Discounted Cash Flow Analysis which is most frequently applied method by the courts and is derived from the Delaware Block Method. It is based on the assumption that the value of the company is the same as the present value of its projected future cash flows.
The Delaware court has never shied away from applying the most suitable of the above method’s and has also not given one method exclusive application over another when dealing with applications for the remedy.
Given the infancy of the remedy in the South African jurisdiction, the decisions and valuation methods prescribed by the Delaware court should soon find application in South African corporate law which will allow for the most efficient and fairest method of valuation to be applied in determining the value of minority shares.