Valuing shares in private companies - how lawyers can help

Key Takeaways

• Share valuation in private companies is essential but often contentious, particularly due to the lack of a public market price.
• Events such as exits, employee departures, funding rounds, or disputes can trigger valuation—and disagreement.
• Variables include financial metrics, share class rights, investor protections, and the qualitative characteristics of the business.
• Bargaining power matters—majority shareholders or early investors may influence how valuation rules are framed and applied.
• Well-structured valuation mechanisms help manage risk, prevent disputes, and ensure fairness. By negotiating these terms with expert legal input and with a clear view of future events, businesses can protect value, attract investment, and promote smooth transitions when change occurs.
• Share valuation mechanics should be agreed early, ideally at incorporation or upon a funding round, to avoid conflict later.

Why you should think about share valuation at an early stage of your business

In private limited companies, share valuation underpins a wide range of legal and commercial decisions. It determines how equity is priced, taxed, transferred, or redeemed—and who ultimately benefits.

Unlike listed companies, private businesses lack a ready market to set share prices. This makes valuation subjective, context-driven, and often open to challenge. Whether in relation to leavers, employee options, investor exits, or M&A activity, valuation is a key issue that should be addressed early and clearly.

Why Valuation Matters - and to Whom

Valuation is relevant to all major stakeholders:

• Founders and employees want to ensure they’re fairly rewarded for building the business.
• Investors want their equity priced accurately for both entry and exit, often negotiating specific protections.
• Companies need to comply with tax rules and create share schemes or exits without disputes.
• Minority shareholders may be particularly exposed if valuation terms are not transparent or if they lack negotiating power.

When Does Share Valuation Become Relevant?

Valuation becomes critical in many common scenarios:

• Leaver situations: When an employee or founder leaves, shares may be bought back at full market value (good leaver) or a discounted or nominal rate (bad leaver).
• Share transfers: Involuntary or voluntary transfers, for example due to death, family succession, internal restructuring, or exit planning.
• Fundraising and investment rounds: Incoming investors will negotiate valuation to determine their equity stake and may seek to adjust it through ratchets or discounts.
• Exit events: Company sales, IPOs, and management buyouts require share values to be agreed for all classes of shareholder.
• Option exercises: Employees exercising EMI or unapproved share options need a defensible share price to ensure tax compliance.
• Disputes or litigation: Divorce, shareholder fallout, or unfair prejudice claims often centre around what shares are “worth.”
• Investor exits or secondary sales: Outgoing investors may sell shares to incoming backers or to the company itself, triggering a pricing exercise.

Notably, in most of these situations, the timing and terms of valuation may be influenced by bargaining positions. Founders with a majority or key investors with preferential rights can often dictate how—and at what value—shares are transferred.

Understanding the Variables in Share Valuation

Valuation involves a mix of hard metrics and softer judgment:

Financial metrics might include:

• EBITDA or revenue multiples
• Net asset value
• Discounted cashflow projections
• Historical earnings and performance

Legal and commercial features often include:

• Share class rights (e.g., preference, conversion, liquidation)
• Investor protections (e.g., anti-dilution, ratchets)
• Drag-along/tag-along rights
• Transfer restrictions and exit mechanics

Other contextual factors include:

• Industry sector and market trends
• Competitive positioning
• Customer concentration or key contracts
• Intellectual property or proprietary technology

Because of these variables, valuation is highly situational, what makes sense in a pre-revenue tech start-up may be wholly inappropriate in a profitable, asset-heavy family business.

Bargaining Power and Negotiating Dynamics

Valuation clauses, like many legal provisions, are shaped by commercial leverage.

• Founders may accept punitive bad leaver clauses or restrictive valuation methods in early rounds in exchange for vital funding.
• Majority shareholders or institutional investors often push for formula-based valuations or drag-along rights that may dilute minority interests.
• Employees and option holders generally have limited influence on valuation rules unless protections are negotiated upfront.

This is why the time to address valuation mechanics is early, preferably at incorporation, during the first funding round, or when share schemes are introduced. Waiting until an exit, dispute, or leaver event arises leaves parties exposed and reduces options.

The Role of Lawyers

Lawyers can assist all stakeholders by:

• Drafting clear, enforceable valuation clauses in shareholders’ agreements, articles and option plans.
• Specifying trigger events, definitions (e.g., good vs. bad leaver), and valuation mechanisms (e.g., market value, independent expert, or fixed formula).
• Negotiating fair protections for minority shareholders or investors.
• Aligning valuation rules with tax strategy and ensuring HMRC compliance where needed.
• Establishing resolution procedures (e.g., independent expert determination) in case of dispute.