The “Minority Interest Discount” in LLC Statutory Buyouts
A prior post — Statutory LLC Buyouts – “Fair Value” vs. “Fair Market Value” — covered an unpublished opinion filed in 2021 addressing the difference between the statutory buyout processes governing California corporations and LLCs.
Statutory corporate share buyouts, governed by Corporations Code section 2000, apply a “fair value” standard, which is determined on the basis of “liquidation value.” Under that standard, “valuation discounts for market factors, such as lack of control, are not permitted.”
In contrast, statutory buyouts of LLC membership interests, governed by Corporations Code section 17707.03, apply a “fair market value” standard, with no reference to “liquidation value.” This “market-based” standard can include “valuation discounts based on the amount a hypothetical willing and able buyer would pay for the interest in the marketplace,” which can include a discount for “lack of control.”
Evading the LLC Jungle’s radar was a second opinion filed in 2021 — this one published and therefore binding precedent — addressing the concept of a “minority interest discount” in connection with a statutory buyout of a LLC membership interest. That case — Cheng v. Coastal L.B. Associates, LLC — is belatedly covered here.
Facts: LLC member sues for dissolution; statutory buyout triggered
Clary Associates, LLC was owned equally by siblings Bernice Cheng, Arlene Change, Caroline Cheng Jones, and Diana Cheng. Bernice field an action for involuntary dissolution of the LLC. The remaining siblings exercised their statutory buyout right under section 17707.03.
The court appointed three appraisers to value Bernice’s 25% membership interest. At the time of the appraisal process, the LLC’s sole asset was a single-story industrial warehouse located in San Gabriel. The appraisers submitted a joint final report agreeing on a “net asset value” of $831,973 for a 25% interest in the LLC as of the valuation date. The report also stated that a majority of the appraisers agreed that the “fair market value” standard required consideration of discounts and “the value should be $623,979 after the application of a 27% discount applicable to a minority interest” in the LLC.
Trial court: appraisal with minority interest discount confirmed
The trial court issued an order confirming the appraisal, including the minority interest discount.
Bernice appealed.
Court of Appeal: affirmed
The Court of Appeal affirmed the trial court’s order, holding that the minority interest discount was not erroneous.
The court adopted the view of the majority of the appraisers, who “agreed that the fair market value standard requires consideration of discounts and that a 27 percent discount should be applied to the 25 percent LLC interests.” The concept of fair market value reflects “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
The court referred to the report of one appraiser citing an IRS Revenue Ruling requiring discounts to be considered when valuing fractional interests and explaining that a “lack of control discount” is applicable for minority interests — i.e., interests less than 50%. The appraiser also pointed to “the general unavailability of conventional financing” for partial interests. To arrive at the 27% discount, the appraisers properly relied on “sales of real estate limited partnership interests in the secondary market,” “specialized closed end funds holding real estate assets,” and “restricted stock transactions.”
The court concluded: “The 27 percent discount applied by a majority of the appraisers and confirmed by the trial court is consistent with commonly understood fair market valuation principles….” The court also rejected Bernice’s argument that the different valuation standard for corporate share buyouts under section 2000 should apply to LLC membership interests.
Lesson
For statutory LLC buyouts governed by Corporations Code section 17707.03, the value of minority membership interests are likely to be discounted.