Valuing minority shares from friends & family without personal guarantee

November 08, 2022

by a searcher from University of Georgia in Atlanta, GA, USA

I am going to let some friends and family buy a small ownership % in the business I am trying to purchase. They will not have to sign a PG, and I want to price the shares as fairly as possible.

For example: Alice and Bob buy a company for $100. SBA loan for $80. Alice owns 95% and signs a personal guarantee for the loan. Bob owns 5% and does not sign a PG. There are 20 shares in the company.

The simplified version would be for Alice to invest $19 in cash for 19 shares (95%$20 = $19) and Bob invests $1 in cash for 1 share (5%$20 = $1); however, Bob’s shares are more valuable than Alice’s shares because Bob’s downside is limited. If the company goes to $0 Bob will only lose $5, but Alice will lose $19 + $80 loan she personally guaranteed.

Is there a standard way to price shares for a minority shareholder who does not sign a personal guarantee? The downside and upside risk of the business will make a big difference in share price, but I am just looking for a starting point.

Is there a way people structure these deals resolve the difference in share value? Perhaps part of Alice shares get treated more like a like a lender providing debt since she takes on the downside risk?

Reply by an investor
from Fort Lewis College in Denver, CO, USA

I have a lot of opinions on this having been on both sides of the table. First, I think arbitrarily pricing it at a higher price is going to get sophisticated investors to walk away quickly! Most will view that as playing games and not being completely transparent.

I also have found that many SearchFunders have this general idea that if they debt finance 80% of the deal, then that 80% is their equity because they made the PG. I believe that thinking is flawed for several reasons. First, that principal and interest payback is being serviced by the business. If the SearchFunder was making all the debt payments personally (i.e. not from the company), I think that logic makes perfect sense.

The other aspect is the risk of the equity capital. The most "at risk" capital in the capital stack equation is that equity. If the business loses 10% of it's value, the investor has taken a 50% loss! That is why most investors want additional equity above their % of the total capital in the deal. That should come with a premium. How much really boils down to what you can negotiate.

Reply by a searcher
in Los Angeles, CA, USA

Sounds like you just need to have two class of shares. Your total transaction value is $100; you are raising $20 in equity, of which $19 (19%) you will invest. For the remaining 1% equity / investment, how much ownership are you willing to sell? 1%? 5%? 10%? It's up to you to negotiate that and for the investor to decide if the $1 investment will provide enough of a return for them. You will end up with certain class of shares valued at X and the investor will end up with certain class of shares valued at Y....

so a scenario could be the company has total 100 units, and the $1 investor ends up with 10 Class A shares, and you end up with 90 Class B shares. In this case you have valued their $1 investment at 10% equity in the company. simple example, and can be more complex than that, especially if the class A has a preference rate etc.

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