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Valuation Battle Ends with $12M Verdict & $58M Minority Shareholder Buyout

Updated: Jan 11

Koch v. Koch (No. 27-CV-18-20579, 2022 WL 1467980 (Minn. Dist. Ct. May 06, 2022)) involved a shareholder dispute among three brothers who owned two businesses in Minnesota. The plaintiff, Jim Koch, had a falling out with his brothers, Randy, and Dave Koch (the defendants), resulting in a deteriorated relationship and disputes over the terms of a temporary agreement made in 2006. An IRS audit triggered disagreements regarding tax deductions under the agreement. The defendants' actions were deemed by a jury as breaching the 2006 agreement, leading to a damages award of $12 million. Subsequently, a bench trial was held to determine the value of the two businesses for the purpose of Jim's buyout. Both sides presented expert valuation opinions, which is the focus of this analysis.


The Parties


Jim Koch owned a 33 1/3% share of Koch Industries, Inc. (“KI”) and a 30.3136% share of Stan Koch & Sons Trucking, Inc. (“SKT”). Randy Koch owned a 33 1/3% share of KI and a 34.8432% share of SKT, while Dave Koch owned a 33 1/3% share of KI and a 34.8432% share of SKT. These three brothers were the sole shareholders of both companies. SKT operated as a trucking and transportation company, while KI functioned as a distributor of chain, cable, rope, and related products in the U.S.


The 2006 Settlement Agreement


The 2006 settlement agreement outlined various provisions, including the requirement for unanimous written agreement among the brothers for any sale of SKT below a specific net value. The agreement also provided for regular bonus distributions and specified bonus payments for SKT and annual pre-tax profits of KI. The issue of tax deductibility of these payments became a point of contention between the parties. Following an IRS audit, bonus payments were suspended, leading to a breach of the agreement as determined by the jury.


Jury Decision and Competing Valuation Opinions


After the jury trial, the parties agreed to a buyout of the interests held by the plaintiff, Jim Koch. Competing valuation evidence was presented to the court. Robert Strachota testified as Jim's valuation expert, while Ginger A. Knutsen testified as the defendants' valuation expert. Both experts employed various valuation methodologies and but differed on the proper valuation date. Knutsen submitted additional valuations after the trial, including the impact of the jury's $12 million award, but the court disregarded these supplemental analyses. Strachota valued Jim's interests in both companies at $72,830,000 based on the latest valuation date, while Knutsen valued them at $39,541,000 based on the earliest valuation date.


Strachota's Valuation Opinions in Support of the Plaintiff


Strachota performed valuations for both KI and SKT as of May 31, 2017, May 31, 2018, and May 31, 2020. His extensive experience as a real estate and business appraiser allowed him to appraise SKT's equipment effectively. Strachota employed the same methodology for all three valuation dates, ensuring consistency and reliability in his assessments. He accurately determined Jim's pro rata share of each business as a going concern at each valuation date. Notably, he did not apply either a DLOM (Discount for Lack of Marketability) nor a DLOC (Discount for Lack of Control) to Jim's interest in either company.


Strachota's Valuation of SKT


Strachota observed that the value of SKT increased over time for the three valuation dates. He attributed this increase to the company's improved performance, increased investment in equipment, and a decrease in the corporate tax rate in 2017.


Income Approach: Employing the discounted cash flow (DCF) method, Strachota prepared pro forma income statements for the five years following the valuation dates. He calculated a consistent 11.7% invested capital discount rate for all three periods. His assessment using the income approach determined that SKT's fair market value (FMV) was $168,000,000 in 2017, $198,000,000 in 2018, and $218,000,000 in 2020. The opinion provided specific details regarding the assumptions used in determining the cash flows.


Market Approach: Strachota employed the market approach by identifying and adjusting 10 sales transactions from the DealStats database of privately held trucking companies between 2004 and 2019. He utilized selected multiples of market value of invested capital price to revenues and market value of invested capital price to EBITDA. Through this approach, he concluded that SKT's FMV, using the market approach, was $169,000,000 in 2017, $198,000,000 in 2018, and $223,000,000 in 2020.


Asset Approach: In the asset approach, Strachota employed the capitalized excess earnings method. He combined the tangible net worth of SKT's assets at market value with the goodwill value derived from capitalizing excess earnings. Strachota assessed the value of SKT's goodwill as $30,089,728 in 2017, $33,556,048 in 2018, and $35,118,892 in 2020. He concluded that SKT's FMV, using the asset approach, was $166,000,000 in 2017, $192,000,000 in 2018, and $193,000,000 in 2020.


Reconciliation of Value: Strachota derived the reconciliation of value by assigning weights to each valuation approach. He weighted the income approach at 50%, the market approach at 35%, and the asset approach at 15%. This comprehensive reconciliation ensures a balanced and reliable assessment of SKT's fair market value, serving as a valuable resource for business litigators, trusts and estate lawyers, and wealth managers.


Strachota's Valuation of KI


For KI, Strachota employed similar valuation methodologies.


Income Approach: Strachota utilized the DCF methodology used for SKT in the income approach for KI. He applied a consistent 19.3% invested capital discount rate to his cash-flow projections. His assessment concluded that KI's fair market value, using the income approach, was $29,860,000 in 2017, $25,640,000 in 2018, and $21,570,000 in 2020.


Market Approach: For the market approach, Strachota employed 26 DealStats transactions and utilized similar metrics as those used in valuing SKT. Based on this analysis, he concluded that KI's fair market value, using the market approach, was $30,810,000 in 2017, $25,820,000 in 2018, and $23,390,000 in 2020.


Asset Approach: Strachota adopted a similar approach for the asset valuation of KI as he did for SKT.


Final Opinions of KI: For the final opinions of KI, Strachota weighted the income approach at 50%, the market approach at 35%, and the asset approach at 15%. This balanced approach ensures a comprehensive assessment of KI's value.


Knutsen's Valuation Opinions in Support of the Defendants


Ginger Knutsen, an esteemed expert in the field, was engaged as the defendants' valuation expert. She performed valuations of both SKT and KI as of May 31, 2017, and subsequently provided additional valuation reports for May 31, 2018, and May 31, 2020, as permitted by the court.


Valuations of SKT by Knutsen


Knutsen's approach to valuing SKT involved careful consideration of various factors, including the acquisition of JBS Logistics and its impact on future projections. By applying different valuation methodologies, she aimed to provide a comprehensive understanding of SKT's fair market value.


Income Approach: For the income approach, Knutsen utilized the capitalization of earnings method, considering an average of past earnings. Using a weighted average cost of capital (WACC) rate and an iterative process, she determined a discount rate of 8.76% and a capitalization rate of 5.76% after deducting a 3% growth rate. Knutsen's valuation of SKT as of May 31, 2017, yielded a fair market value of $97,659,000. Additionally, her supplemental reports, employing similar methodologies with WACC capitalization rates of 7.45% for 2018 and 7.19% for 2020, arrived at income approach values for SKT of $115,694,000 as of May 31, 2018, and $122,362,000 as of May 31, 2020.


Market Approach: Knutsen utilized guideline transactions or comparable sales for publicly held companies, deviating from Strachota's use of private-company transactions, to derive the market approach values for SKT. By analysing recently filed 10K's and 10Q's for six comparable public companies, Knutsen determined the fair market value of SKT as of May 31, 2017, to be $108,931,000. Moreover, her supplemental reports, using the same guideline companies, arrived at market approach values for SKT of $123,817,000 as of May 31, 2018, and $134,609,000 as of May 31, 2020.


Asset Approach: In the asset approach, Knutsen assessed the value of SKT's tangible assets by analysing the balance sheet and making necessary adjustments. She determined that no value could be attributed to goodwill, considering that earnings did not justify its presence. Additionally, she included deferred income taxes as a liability at a value of $28 million. Knutsen's assessment under the asset approach revealed a value of $106,530,000 for SKT as of May 31, 2017. Furthermore, her supplemental reports yielded asset approach values of $129,870,000 as of May 31, 2018, and $132,620,000 as of May 31, 2020.


Reconciliation of Value: Knutsen conducted a comprehensive reconciliation of SKT's value, placing emphasis on the asset approach due to the asset-intensive nature of the business. For each year, she added the value under the asset approach to any non-operating assets. Consequently, the value for 2017 totalled $107,092,000 after incorporating $562,000 for non-operating assets. In 2018, no non-operating assets were identified, resulting in a total value of $129,870,000. Finally, for 2020, Knutsen added the value of leased-out Cottage Grove real estate amounting to $4,026,000, characterized as a non-operating asset, leading to a total value of $136,646,000 for SKT.


Valuation of KI by Knutsen


Knutsen's valuation of KI involved the application of similar valuation approaches.


Income Approach: Under the income approach, Knutsen used the capitalization of earnings method, determining an appropriate capitalization rate of 16.7%, 17.3%, and 15.2% for the respective periods. Her valuations for KI as of the three dates were $16,694,000, $17,926,000, and $17,518,000.


Market Approach: Utilizing DealStats, Knutsen identified seven comparable transactions; however, these transactions were based on a NAICS code different from the SIC code used by Strachota. Nonetheless, through this approach, Knutsen arrived at fair market values for KI of $18,000,000, $17,500,000, and $19,800,000 for the respective dates.


Asset Approach: Knutsen valued KI's tangible assets and liabilities, making adjustments to their estimated fair market value on a going-concern basis. She assigned zero value to goodwill, considering the company's earnings did not warrant its inclusion in her view. Her assessment under the asset approach concluded that KI's value as an operating company as of May 31, 2017, was $17,223,903, with non-operating assets valued at $4,235,364. Furthermore, her supplemental reports arrived at asset approach values for KI as an operating entity of $18,293,437 as of May 31, 2018, and $18,631,875 as of May 31, 2020.


Reconciliation of Value for KI: Knutsen, considering the specific circumstances, did not utilize the market approach in her final value reconciliation for KI. Furthermore, she determined that the income approach resulted in a lower value than the asset approach due to KI's lack of debt, leading to a higher weighted average cost of capital (WACC). Consequently, Knutsen determined that the total fair market value of KI's operating and non-operating assets for the three valuation dates amounted to $21,235,364, $21,825,252, and $18,135,000. Knutsen's computations to account for the jury award of $12 million were excluded by the court.


Key Differences in Valuation Approaches


The court found Strachota's primary reliance on the income and market approaches more credible than Knutsen's primary reliance on the asset approach. Strachota's extensive experience in valuing trucking companies and his comprehensive analysis of income and market factors contributed to the court's favourable assessment of his opinions. The court also highlighted Strachota's collaboration with an independent appraiser to determine the value of SKT's equipment, which added credibility to his valuation.


Regarding the income approach, Knutsen tax-affected cash flows based on historical earnings, while Strachota used the discounted cash flow (DCF) method without tax affecting the cash flows, which the court accepted as more appropriate. Strachota's utilization of the DCF method and industry-standard metrics, such as EBITDA, contributed to the court's preference for his income approach.


In the market approach, the court found Strachota's use of appropriate adjustments and control prices for privately held companies more credible than Knutsen's sole reliance on public company comparables. The court recognized the need to adjust the minority price to equate it to a control price, which Knutsen had failed to do.


Additionally, the court accepted Strachota's approach of excluding deferred taxes from the asset valuation, as most appraisers do not consider them unless a buyer is likely to assume the liability. This contrasted with Knutsen's reduction of value by the present value of the deferred tax liability.


Other factors that influenced the court's preference for Strachota's opinions included his use of different risk premiums based on customer concentration and market factors, as well as his consideration of industry average capital expenditures (CapEx) percentages.


Conclusion


In almost all instances where the experts' opinions diverged, the court found Strachota's valuations more credible than Knutsen's. While the court acknowledged that Strachota's values were somewhat generous, it determined that they were still above the midpoint of the reasonableness range. Considering the valuation date of May 31, 2017, the court concluded that the fair value of SKT was $160,000,000, and the fair value of KI was $30,000,000.


This case analysis underscores the importance of comprehensive and well-supported valuation opinions in shareholder disputes. Strachota's expertise, robust analysis, and alignment with industry practices were key factors in the court's assessment.


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