Analysis of the legal realities of applying market discounts for minority and low liquidity to the price of a share of an LLC participant upon its release + American approach
Today, one of the main problems faced by corporation members when a participant withdraws or expels from the company is the determination of the value of the share of the leaving (excluded) participant, a real and, most importantly, fair assessment of his investment in the authorized capital. Anastasia Shvets tells in great detail how market discounts are applied today for minority and low liquidity to the price of a share of an LLC shareholder when it leaves
The Civil Code of the Russian Federation, in particular, paragraph 1 of Article 67, paragraph 6 of Article 93 and the provisions of the Federal Law of February 8, 1998 No. 14-ФЗ “On Limited Liability Companies” (hereinafter – the Law on LLC), the legislator expressly indicates the obligation of the company pay the participant the actual value of his share upon exit from the LLC.
The above-mentioned norms, in turn, raise a whole series of questions. In particular, is the linking of the size of the cash payment to the presence or absence of the private owner of corporate control and a ready market for his package valid? Will the monetary compensation be the same in cases where a participant is expelled from the company, for example, due to the constant blocking of decision-making that significantly affects the financial and economic activities of the company and thereby causing harm to the corporation, or when he left the company, citing the possibility, stipulated by the charter? On the whole, the question can be formulated more broadly: do circumstances that served as the reason for the exit and circumstances of an external nature (the venture nature of the activity or the small size of the society, and so on) matter when determining the compensation to a participant in the company? This article will provide answers to some of these questions.
Repeatedly in Russian legal reality, the question arose about the use of lowering coefficients in determining the amount of compensation in the event of a withdrawal (exclusion) of a minority participant from society. It is, in particular, about applying a discount for lack of control (discount for minority) and a discount due to the lack of a liquid market for such a share (discount for illiquidity).
The discount for minority is a kind of reflection of market concerns that the buyer’s corporate capabilities, such as approving certain transactions, the ability to influence decision-making on the payment of dividends, and obtaining information related to the company’s activities, will be negligible compared to the capabilities of other participants.
According to some researchers, the discounts for minority, as well as the premium for the controlling stake, reflect the cynical reality of the market, because based on such a discount and bonus system it is clear that being a majority is to derive additional benefits from participating in the enterprise’s business processes and not sharing these preferences with minority shareholders. In other words, the minority discount is based on the presumption of the market that the majority always abuses or has the motive and ability to abuse its control position at the expense of the minority shareholder and that is why the market requires a discount in order to take such a vulnerable position of the participant in the turnover. However, if in a public society the oppressed or stolen minority participant can simply sell his shares on the open market, then in a closed corporation he most often has nowhere to go, and this, in turn, leads us to a discount for illiquidity.
The discount on illiquidity is a reflection of the lack of a closed sales market for closed interest participants in closed corporations. The analogues of a closed corporation in Russia include, first of all, limited liability companies, the most common form of legal entity to date. And if we compare their position with the position of participants in a public company, then the second is much easier to realize their share and find a buyer, but a member of a closed corporation a priori is in a less favorable position. Who wants to buy a stake from a minority shareholder who does not directly participate in the distribution of profits due to the fault of the majority, which does not distribute this same profit for years, but directs and redistributes it to more significant projects for it, the so-called petprojects.
The term Petprojects refers to projects most often with a low return on invested capital, on which persons controlling the company prefer to spend the money earned by the company, instead of distributing them as dividends between shareholders, and which bring such tangible and intangible benefits to such persons.
Among other things, closed societies are most often created by persons having trusting or other informal relationships, and personal contribution to the development of a corporation is not limited to only paying a share in the authorized capital.