What’s the “Skinny” on “Skinny Voting Shares”?
The valuation of skinny voting shares has recently become a topic of discussion among valuation professionals.
First off, what are skinny voting shares?
The most common situation we see involving skinny voting shares occurs when the owners of a family business wish to involve their children in the ownership of the Company. This is often accomplished by having the Company issue preference shares to the parents, which have a total redemption value equal to the fair market value of the Company. The Company then issues common shares to the children at a nominal value. This effectively “freezes” the current value of the Company to the parents, and allows future growth to accumulate to the children. Depending on the number of shares involved, this may give the children voting control of the Company. However, for a variety of reasons, the parents may not wish to give up control of the Company. One method through which control may be retained by the parents is to have the Company issue a class of shares to them that have “super” voting rights. Typically, these shares are not entitled to dividends, have a nominal redemption/retraction amount and are not entitled to share in the economic value of the Company. Since these shares are not entitled to any financial return, they are often referred to as “skinny voting shares”.
In most cases, the determination of the fair market value of a Company (and its shares) is a function of the future expected cash flows and the risk of realizing those cash flows. While the skinny voting shares give voting control of the Company to their owner, they only have a nominal financial return. This raises a question about the proper valuation of skinny voting shares. Is there value to shares that provide voting control but no financial return for the investment in shares?
Historically, Canada Revenue Agency (CRA) has allowed taxpayers to assign a nominal value to any skinny voting shares held. As a result, when valuing skinny voting shares, many valuation professionals simply assign a nominal value to the skinny voting shares. However, in a recent court case, the court assigned a value to skinny voting shares. Naturally, this decision has led to some discussion among valuation professionals regarding historical practice and the proper approach to valuing skinny voting shares.
The rationale that skinny voting shares should be assigned only a nominal value is that a prospective purchaser is typically interested in acquiring the future growth of the Company. Since the future growth does not accrue to voting skinny shares, they would appear to have limited value. The argument that some value may be attributable to the skinny voting shares is that these shares hold the majority voting control of the Company, and that this, in itself, has value. In actual practice, we would generally expect that a purchaser would seek to acquire both the skinny voting shares and the shares that participate in the future growth of the Company. As such, a prospective purchaser would be interested in a combined value, rather than a specific value for each type of share. If a value must be allocated among the different types of shares, the rationale for this allocation must be supported.
Ultimately, the valuation should involve a careful analysis and consideration of the numerous factors and considerations unique to that particular business, that impact both the enbloc value of the Company and the allocation of that value to the specific classes of shares. The Chartered Business Valuators at DJB would be pleased to assist you in navigating this complex area.
If you have any questions or require assistance in this regard, please contact a member of our Financial Services Advisory Team (FSAT).