"Fair value" is the standard generally applied in dissenting shareholder and shareholder oppression cases. Although the meaning of fair value varies depending on state law, it’s frequently defined as a proportional share of total enterprise value without regard to discounts (for lack of control and marketability) typically applied to minority interests.

The concept of fair value is intended to prevent a controlling business owner from obtaining an unfair benefit. In a "squeeze out" merger, for example, use of fair market value to determine the compensation of minority shareholders might result in a windfall to the controlling shareholder.

On the other side of the coin, should the data used to determine fair value include a premium for the value of the company if purchased as a whole? It seems fair that the price for a minority interest should not be discounted for the very lack of control and marketability that make it possible for the minority owner to be forced out. But the price should also be fair to the controlling shareholder. Consider this example:

A majority shareholder creates a new company, merges the existing company into the new company, and offers to buy out the minority shareholder. The minority owner offers evidence that similar companies in the industry are selling for ten times earnings. This evidence includes transactional data reported to the SEC by public companies that have acquired closely held companies. The problem with such data is that the prices may include a strategic or "synergistic" premium and, therefore, may not reflect the price that would be paid by a financial buyer.

Often, when a public company acquires a closely held company, the price is based on the acquiring company's ability to alter the acquired company’s income stream or eliminate competition. There are a number of ways to achieve these objectives, such as:

• Taking advantage of economies of scale
• Consolidating market position
• Making use of excess capacity in a manufacturing operation
• Reducing management costs
• Using relationships with suppliers to reduce the acquired company’s cost of goods sold

As a result of these advantages, the strategic buyer may pay a significantly higher price than a buyer who would operate the business "as is." But in a dissenting shareholder situation, the company’s income stream generally doesn’t change. To avoid overcompensating the minority owner, therefore, it’s important to recognize and adjust for strategic premiums built into earnings multiples derived from public company data.

Note: Although this article focuses on fair value, similar considerations may apply to fair market value as well.