Fair Value vs Market Value: Valuing Shares Under a Shareholders' Agreement

Fair value or market value: why the wording matters

Almost every UK shareholders' agreement and set of articles contains a clause telling the parties how shares are to be priced when someone leaves, dies, defaults or is bought out. The clause usually uses one of three phrases: fair value, market value or fair market value. They are not synonyms, and the difference between them regularly moves the price of a minority holding by 30% to 50%.

The valuer does not choose the basis. The document does. The valuer's first job on any shareholder instruction is to read the clause and identify precisely which basis it imposes.

The three bases in UK practice

The practical consequence: a 20% holding in a company worth £5m is worth around £1m on a fair value basis and might be £490,000 on a market value basis after a 30% minority discount and a 30% DLOM. Same company, same day, same shares.

Fair value: the proportionate share approach

Fair value treats the departing shareholder as entitled to their arithmetical slice of the enterprise, on the basis that they are not making a voluntary sale into an open market. It is the basis the courts usually apply in unfair prejudice petitions under section 994 Companies Act 2006, and it is the basis most well-drafted agreements adopt for good leavers and for death.

Under a fair value clause the valuer:

1. Values 100% of the equity, normally on normalised EBITDA multiples cross-checked against a DCF or asset basis.

2. Divides by the fully diluted share count.

3. Multiplies by the shares held.

4. Applies no minority discount.

5. Applies a DLOM only if the clause expressly permits it, which is unusual.

Where the clause simply says "fair value" without further definition, English practice is to read it as a proportionate share of the whole unless the surrounding drafting clearly indicates otherwise.

Market value: the hypothetical purchaser approach

Market value applies the statutory standard used for tax: the price the shares would fetch on a sale in the open market between a hypothetical willing buyer and willing seller, both with full information about the company. Because a hypothetical buyer of a 20% block is buying a position with no control and no liquidity, both the minority discount and the DLOM apply.

This is the correct basis where:

• The clause expressly says "market value" or references section 272 TCGA 1992.
• The transaction is a tax event: a gift, an inheritance tax return, an employment-related securities valuation.
• The valuation is for HMRC Shares and Assets Valuation rather than for the parties.

Good leaver, bad leaver and the price ratchet

Most modern UK agreements do not apply a single basis. They tier it by the reason for departure:

The valuer must be told which category applies before starting. Being asked to produce "a valuation" without the leaver classification is the most common cause of a report having to be reissued.

Drafting failures that cause disputes

• "Fair market value" with no definition. The two components pull in opposite directions. Courts have had to construe it repeatedly, and the outcome depends on the rest of the agreement.
• Silence on discounts. If the clause specifies a basis but not whether discounts apply, the parties can each produce a defensible valuation £400,000 apart.
• Silence on the valuation date. Departure date, notice date, completion date and last accounts date can be six months apart.
• No treatment of surplus cash or director loans. Frequently the largest single adjustment in an SME.
• Undefined "the Company's accountants". Where the same firm advises the majority, the minority will challenge independence.
• No expert determination mechanism. Without one, the only remedy is litigation.
• No provision for a deadlock in the process. If one party refuses to co-operate with the expert, the clause can stall indefinitely.

The valuer as expert determiner

Many agreements appoint an independent valuer as expert rather than arbitrator. That distinction has real consequences:

• An expert determination is binding and can generally only be challenged for manifest error, fraud or departure from the instructions in the clause.
• The expert is not bound by the rules of evidence and can use their own knowledge and enquiries.
• There is no automatic right to see the other party's submissions unless the clause provides for it.
• The expert must apply the basis in the clause exactly, even where they would have chosen differently.

A valuer accepting an expert determination appointment should confirm in writing, before starting: the basis of value, the valuation date, the treatment of discounts, the information both sides will provide, and whether a reasoned determination is required.

Worked example

A UK services company with normalised EBITDA of £900,000 is valued on a 5x multiple, with net cash of £300,000.

• Enterprise value: £4.5m
• Equity value (100%): £4.8m

A shareholder holding 22% resigns after four years.

If the clause says fair value (good leaver):

`£4,800,000 x 22% = £1,056,000`

If the clause says market value (intermediate leaver):

• Minority discount: 30% (no blocking rights, concentrated register)
• DLOM: 25% (no exit process, restrictive pre-emption regime)

`£1,056,000 x 0.70 x 0.75 = £554,400`

If the clause says bad leaver at the lower of subscription price and market value, and the shares were subscribed at £50,000:

`£50,000`

The company is the same in all three cases. The clause decides the answer.

Reading your own clause: a checklist

Before instructing anyone, confirm the document answers all seven:

1. What basis of value applies, in exact words?

2. Does the clause state whether minority and marketability discounts apply?

3. What is the valuation date?

4. Who appoints the valuer, and what happens if the parties cannot agree?

5. Is the valuer acting as expert or arbitrator?

6. Who pays, and does the loser bear costs?

7. Are payment terms defined, including any deferral or instalment mechanism?

Where the answer to any of these is unclear, resolving it before the valuation is far cheaper than litigating it afterwards.

Fair value in unfair prejudice petitions

Where no clause exists, or where the conduct complained of makes the clause inequitable, section 994 gives the court a wide discretion. The established starting point for a quasi-partnership company is a purchase of the petitioner's shares at a proportionate share of the whole, without a minority discount, on the basis that the petitioner is being excluded rather than choosing to sell. That is covered in detail in the section 994 guide.

Common mistakes

FAQ

Related guides

• Minority discount: how UK minority shareholdings are valued - the discount a fair value clause removes
• Marketability discount (DLOM) explained - the second adjustment under a market value clause
• Control premium in UK private companies - the same gap seen from the majority side
• Unfair prejudice: section 994 valuations - where the court sets the basis
• Sale value vs tax value - why one company has more than one correct value