An appraisal right is the statutory right of a corporation's minority shareholders to have a judicial proceeding or independent valuator determine a fair stock price and oblige the acquiring corporation to repurchase shares at that price. An appraisal right is a protection policy for shareholders, preventing corporations involved in a merger from paying less than the company is worth to the shareholders.
Breaking Down Appraisal Right
Analysts may use multiple valuation methods in determining the fair stock price and value of the acquired company, including asset-based methods, income or cash flow methods, comparable market data models, and hybrid or formula methods. While most occurrences of appraisal rights are based on consolidation or mergers, they may also apply to instances when the corporation takes any extraordinary action that shareholders deem harmful to their interests. In mergers and acquisitions, appraisal rights guarantee that shareholders receive adequate compensation if a merger or acquisition overrides their wishes.
Appraisal Right and Business Valuation Methods
As noted above, there are several ways to value a business and arrive at a fair stock price to appease shareholders. One way is an asset-based valuation, which focuses on a company's net asset value (NAV), or the fair-market value of its total assets minus its total liabilities. Essentially, this method determines the cost to recreate the business physically. Room for interpretation exists in terms of deciding which of the company's assets and liabilities to include in the valuation, and how to measure the worth of each. For example, certainly inventory cost methods (e.g., LIFO or FIFO) will value the company’s inventory in distinct ways, leading to changes in the overall value of the company’s assets.
Another form of business valuation is using comparable earnings ratios, such as the price-to-earnings or P/E ratio, to determine how a business stacks up against competitors. For example, if a company’s P/E ratio is the highest among its peer group, either it truly has a promising edge in the field (perhaps a new technology or acquisition in a new market niche) or it is overvalued (i.e., its price is too high, compared to its actual profits).
Finally, independent evaluators might use the discounted cash flows or DCF method to arrive at an objective stock price in an issue of appraisal right. In contrast with the comparables method above, which is a relative valuation method, the DCF method is considered an intrinsic method, independent of any competitors. At its core, the DCF method relies on projections of future cash flows. These are then are adjusted to get the current market value of the company.