Orville Lefko's criticism of case law on the valuation of minority interests in closely held businesses (November/December 2005 issue) conflates two conceptually distinct issues: (1) how to determine the value to existing shareholders of a minority interest in a closely held business, and (2) whether it is wise for a stranger to invest in a closely held corporation — he posits "why would anyone ... buy a minority interest in a closely held corporation?" By doing this, he incorrectly concludes that minority interests are essentially without value.

Though a stranger to a closely held business might not have good reason to purchase a minority share of stock for the reasons Lefko gives, existing shareholders (those who are typically parties to the divorce proceedings or shareholder oppression suits Lefko references) have strong reasons for purchasing a minority interest.

For instance, assume that the husband owns a one-third interest in a small business in which he is CFO. He and his two other partners each receive $333,333 annual compensation. Is the husband's minority interest not worth anything as Lefko would seem to conclude — he states: "Common sense should dictate against the purchase of a minority interest at any meaningful price ." (emphasis added)

Years later, when the husband and his two partners get into a dispute, Lefko's analysis would suggest that the husband's 33 percent interest has no value. Though there may not be a market among the general public for the minority interest, certainly the two remaining partners will be interested in owning the husband's stock so they can divvy among themselves the husband's $333,333 salary. Courts are there to ensure that the majority shareholders (and divorcing spouses) do not abuse their monopoly purchasing power to unfairly reduce the purchase price. Lefko disregards these considerations to reach a conclusion that does injustice to the already disadvantaged.

— Christopher C. Kendall
Chicago

It is Mr. Kendall who is conflating two issues. My article had only one purpose — to set forth reasons why most minority interests have little or no value and so do not qualify as good investments. To quote the article, "The risk/reward ratio for an investment in a minority interest can be favorable only if there is an accompanying, legally enforceable agreement that operates to mitigate the interest's inherent disadvantages." I assume that the minority interests in Kendall's examples are not enhanced by any side agreements.

Kendall says that "a stranger to a closely held business might not have good reason to purchase a minority interest for the reasons Lefko gives" but "existing [majority?] shareholders have strong reasons for buying a minority interest." He says that, in a dispute, the husband's two co-shareholders will be interested in owning the husband's stock so that they can "divvy among themselves the husband's $333,333 salary." Thus, he links the salary to the stock. There is no such connection. Being a shareholder does not guarantee a person employment nor, if employed, a certain salary.

In a divorce action, of course the CFO's one-third interest is worth something. The value would be its value to the CFO, not its value to an outsider. Assuming that a sale of the business or the husband's interest is not presently contemplated, the company and his interest would be valued as if he were remaining as CFO. This procedure reflects the application of what some call the "holder's interest" concept. See the Michigan Bar Journal (May 1992) for my discussion of that concept.

Concerning case law, my article stated, "... erroneous appraisals can often be found in divorce actions, estate and gift tax cases and stockholder disputes as well as in other litigated matters." Working with these faulty "expert" opinions, courts do a commendable job.

— Orville Lefko
Clearwater, Fla.