Divorce and Business Valuationsmedia.straffordpub.com/products/divorce-and-business-valuations-2… · 15/03/2012 · Divorce and Business Valuations Navigating Complex Valuation

Divorce and Business Valuations Navigating Complex Valuation Issues and Methodologies and Analyzing Valuation Impact on Support

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THURSDAY, MARCH 15, 2012

Presenting a live 90-minute webinar with interactive Q&A

Gunnar J. Gitlin, Atty, The Gitlin Law Firm, Woodstock, Ill.

Martin S. Varon, Principal, Alternative Resolution Methods, Atlanta

Sarah McCormack, Partner, Kessler & Solomiany, Atlanta

Daniel E. Clement, Atty, Clement Law, New York

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VALUATION DISCOUNTS AND ENTERPRISE VERSUS

PERSONAL GOODWILL Gunnar J. Gitlin, Gitlin Law

Firm, Woodstock, IL 815-338-9401

[email protected] www.GitlinLawFirm.com

In divorce valuations, often a significant issue is not value of the business, itself, but the discounts applied to the value.

The main discounts to be reviewed are: Minority Interest (Control Premium) and Lack of Marketability.

6

Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL:

www.GitlinLawFirm.com

Will learn how to analyze all of the key discounts and premiums: Includes critical issues:

Key Revenue Rulings Discounts and Premiums 101/102.

Control Premiums/Minority Interest Discounts Lack of Marketability Discounts

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Revenue Ruling 59-60: Little discussion of discounts. Does address key person discount issue – discussed later.

Revenue Ruling 77-287: Early Revenue Ruling addressing lack of marketability discounts.

Revenue Ruling 93-12: Revenue Ruling doing away with so called “family attribution doctrine” previously promoted by I.R.S. Allows application of minority interest discounts to

partial transfers even when a family owns overall control of a closely-held business.

8



Revenue Ruling 59-60: Little discussion of discounts. Does address key person discount issue – discussed later.

Revenue Ruling 77-287: Early Revenue Ruling addressing lack of marketability discounts.

Revenue Ruling 93-12: Revenue Ruling doing away with so called “family attribution doctrine” previously promoted by I.R.S. Allows application of minority interest discounts to

partial transfers even when a family owns overall control of a closely-held business.

9



Key Concept is relationship between nature of ownership interest from

marketable, controlling interest to non-controlling, non-marketable interest upon

valuation discount.

10



STRATEGIC VALUE

CONTROL VALUE

FREELY TRADED VALUE ORMARKETABLE,

NON-CONTROLLING

NON-MARKETABLE,NON-CONTROLLING

Strategic Premium/Merger Economics

Lack of Control Discount

Lack of Marketability Discount

Premium for Control

Obtain indirectly by reference tocontrol values via strategic premium

Obtain indirectly by reference to freelytraded values via control premium

Obtain indirectly by reference to controlvalues via lack of control discount

Obtain indirectly by reference to freelytraded values via lack of marketability

discount

Source: Based on Z. Christopher Mercer, "Understanding and Quantifying Control Premiums: The Value of Control vs. Synergies of StrategicAdvantages, Part II," The Journal of Business Valuation, p.51.

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Type of Ownership Interest

Example

Valuation Premium / Discount

Illustrative Premium / Discount %

Illustrative Impact

on Value

Marketable Control

100% interest for sale to a strategic buyer

Synergistic Premium (Not FMV)

+15%

$115

Marketable Control

100% interest for sale to any willing buyer

No Discount or Premium

None

$100

Marketable Noncontrol

Minority interest in a publicly traded company

Discount for Lack of Control

-20%

$ 80

Nonmarketable Noncontrol

Minority interest in a private company

Discounts for Lack of Control and Marketability

-30%

$ 56

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Control Premium: Additional consideration investor would pay over a marketable, minority equity value (publicly traded stock prices) to own a controlling interest in the common stock of a company. Premium may include components for control and synergy.

Lack of Control Discount (a.k.a. Minority Discount): 50% interest may have lack of control discount although not a minority interest. Neither control nor minority position.

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“There are 51 shares ... that are worth $250,000. There are 49 shares that are not worth a ----.” (See Humphrys v. Winous Co., 133 N.E.2d 780, 783 (Ohio Sup. Ct. 1956) quoting from John H. Doyle, speech before Ohio State Bar Association, July 1893).

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Control versus minority interest not an all or nothing concept.

Examples: Set corporate policy; Appoint management; Determine compensation for management; Determine perqs of management; Acquire or liquidate corporate assets; Declare and pay dividends; etc.

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100% Control. Slightly Less than 100% Control: Minority interest may be a nuisance. Less than 80% control: Cannot consolidate financial statements for tax

purposes. Two-Third Interest: About one-third of the states require more than a

50% (plus one share) vote to approve certain major corporation actions (see chart in written materials). This may be known as super-majority. The various states’ statutory positions on this issue will have an affect on the degree of control.

50% Interest: This interest is neither a control nor minority position. Such a shareholder has the power prevent actions but generally does not have the authority to control action of the company.

Swing Vote - Minority block: This depends upon the distribution of the stock. The relationship between the persons owning other stock may have a value on the swing vote. Example: 1/3 int. to three owners subject to lesser discount.

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Attempt to indirectly examine the range of premiums buyers pay for a controlling interest in a public company.

Two Sources of Data – Compare public market trading prices before announcement of a merger or acquisition to the merger or acquisition price: Mergerstat Review: Publishes annual average control premiums for about

50 broad industry groups. These are averages and exclude negative premiums (takeovers at discounts from previous publicly traded prices).

Mergerstat/Shannon Pratt’s Control Premium Study

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Mergerstat Review: Publishes annual average control premiums for

about 50 broad industry groups. These are averages and exclude negative premiums (takeovers at discounts from previous publicly traded prices).

Mergerstat/Shannon Pratt’s Control Premium Study Online database: all takeovers of public companies

resulting in over 50% ownership since 1998. One feature of this publication is that the transactions are labeled as Financial, Horizontal Integration, Vertical Integration or Conglomerate. May help in assessing the degree of synergy reflected in the control premium.

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Year

Average Control

Premium

Median Control

Premium

Calculated Minority Discount

2007 31.5% 24.7% 19.8%

2006 31.5% 23.1% 18.8%

2005 34.5% 24.1% 19.4%

2004 30.7% 23.4% 19.0%

2003 62.3% 31.6% 24.0%

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Exclusion of Negative Premiums from Averages: Effect is to exaggerate averages

References to Averages Versus Mediums: Averages distorted by a few very high premiums

paid. Control Transactions May Consider

Investment Value: a/k/a “strategic,” “acquisition,” or “synergistic”

value

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Normalization process may include two types of adjustments: Adjustments which may take into consideration

elements of control Other adjustments.

Often valuator may make adjustments to business int. only a control owner could make and then also apply minority interest discount.

21



Illiquidity Discounts: Apply to Control Interest.

Lack of Marketability Discounts: Apply to Minority Interest.

Terms generally measure same thing but the amount of discount significantly differs. Much greater discounts for lack of marketability for

a minority interest.

22



Two Types of Studies: Early Restricted Stock Studies and Later Pre-IPO Studies

Restricted Stock Studies Usually restricted for period of two years.

Restricted stock may occur in various settings: Closely-held Company’s Sale of Unregistered Shares:

Often done to raise capital. Shares Issued When Company Acquired: When this is

done the stock issued is often unregistered and is subject to restrictions on its sale.

Unregistered IPO Shares: Often underwriters of an IPO request that some of the stock not be registered at the time of the public offering.

23



Positives Since marketability is the only difference between

restricted stock and freely traded stock, studies of such stocks are often used to measure the lack of a marketability discount to be applied when valuating a closely-held corporation.

Negatives Because the short time period in which the

restrictions on such stock expire, shares of closely-held stock are expected to require a higher marketability discount compared to the restricted stock of a publicly traded company.

24



Study Years Avg. Discount

SEC 1966-1969 25.8%

Gelman 1968-1970 33.0% Trout 1968-1972 33.5% Moroney n/a 35.6% Maher 1969-1973 35.4% Std Research 1978-1982 45.0% Willamette Mgmt 1981-1984 31.2% Silber 1981-1988 33.8% FMV Opinions April 1992 23.0% Mgmt Planning 1980-1996 27.1% Johnson 1991-1995 20.0% Columbia Fin 1996- Apr 1997 21.0% Columbia Fin May 1997-1998 13.0% LiquiStat Database Regularly

Updated “Almost fits into

separate category.” 25

Beware of Averages Redux: While average discounts in the restricted stock studies are

consistent, virtually all of the studies have a huge degree of variability with the highest discounts being more than 80 percent or 90 percent and with the smallest discounts actually representing a positive number, i.e., a premium.

Studies Show Greater Discounts for Smaller Businesses: Management Planning Study: Median 32.7% under 10M

but 17.0% for larger businesses. New Studies Not Likely:

Due to one year restriction.

26



Example Period: April 2005 to January 2007: Average Holder Period Shares Sold in Secondary

market: 138 days. Shorter than in Restricted Stock Studies. Surprisingly: Significantly higher discounts. Average and Median: 32.8% and 34.6%

27



Importance of Studies: Benchmark to determine the difference between the

value of stock in private transactions before going public relative to the market prices following the initial public offers.

Two significant series of studies: Emory Pre-IPO Studies Willamette Management Assoc. Pre-IPO Studies

28



Study Years

# of Transactions

Average Discount

1997-2000 266 50% 1995-1997 84 43% 1994-1995 45 45% 1991-1993 49 45% 1990-1992 30 34% 1989-1990 17 46% 1987-1989 21 38% 1985-1986 19 43% 1980-1981 12 59% All Studies 543 46%

29

Positives: Studies show higher discounts than restricted stock

studies: better measures effect of marketability. Those with restricted stock know restrictions will expire at end of term.

Negatives: Pre-IPO studies likely measure more than only a

discount for marketability and he correctly suggests that there are multiple enhancements experienced by a company going public

30



Mercer’s Position: “Comparing pre-IPO discounts with marketability

discounts is like comparing apples to oranges.” See, Christopher Mercer, QUANTIFYING MARKETABILITY DISCOUNTS (1997) pp. 89-91.

Qualitative Marketability Discount Model. Model attempts to give more objective indication as

to amounts of lack of marketability discounts.

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Amount of Discount: Discount is significantly less in scope (e.g., 10%

versus 35%). For this reason appraisers are beginning to use the term illiquidity discount.

Common Mistake: Many valuation reports apply significant lack of

marketability discount to controlling interest based upon these studies – which is not proper.

32



Over half the value of a business can be “lost” in the discounting process.

Be aware of when discounts should be applied and when they are not appropriate.

Do not assume the valuator has detailed knowledge of the strengths and weaknesses of discount studies or has properly used them.

If you can’t understand how or why a discount was applied in your client’s valuation report, then neither will the judge.

33



The Bible: Pratt: Valuing a Business 5th Edition, 2008, Part IV

BVR’s Guide to Discounts for Lack of Marketability, 2009:

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Many States: Personal Goodwill Not a Marital Asset: See:

http://www.bvresources.com/FreeDownloads/Goodwillhunting.pdf

Common Mistake: Even in states where no distinction, the failure to try

to skin the cat via another way: e.g., key person discount.

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http://www.bvresources.com/FreeDownloads/Goodwillhunting.pdf�

http://www.bvresources.com/FreeDownloads/Goodwillhunting.pdf�

Two Types of Double Dipping: Property Standards Themselves; Property Versus Maintenance Standards; Other reasons

Personal Goodwill Defined: If goodwill depends on the continued presence of a

particular individual, the theory is that the goodwill is not marketable distinct from the personal. This goodwill is essentially the future earnings of the business owning spouse.

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Illinois case: IRMO Alexander, per Pratt’s Valuing a Business. 368 Ill. App. 3d 192 (Fifth Dist., 2006). Novel Method: Multiattribute Utility Theory or

Model (MUT or MUM). Several steps: Objective; Alternatives: Range of Percentages that define the

choices. Attributes: Element of Goodwill that valuator assigns a

value: Examples: Personal reputation, business location. Creation and Categories up to Discretion of Valuator

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http://www.state.il.us/court/Opinions/AppellateCourt/2006/5thDistrict/September/Html/5050109.htm�

The Onsite Interview’s Importance. Variations in Personal Goodwill Ranges.

Examples: 90% Case: But could other individual take over, etc.

Key Issue: Could you bring in another person at a given salary

to replace the business owning spouse and still maintain the current level or profitability.

Business Valuation and Henry David Thoreau: Simplify. Always simplify. The Challenge. To simplify, you must first

understand. 38



Presenter

Martin S. Varon Alternative Resolution Methods, Inc.

Smyrna, GA

770-801-7292 [email protected]

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Acquiring business through gift, inheritance, or

reorganization

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Spouse owned business prior to marriage or received it by gift or inheritance and is now claiming a separate property interest

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Separate Property Argument • Business has a value of $1,000,000 as of date of

marriage or at time of gift/inheritance • Owner argues this is separate property and

should not be considered as an asset for equitable distribution

• Owner maintains ownership in a separate account and does not commingle profit distributions (dividends) with any jointly held investments

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During the Marriage

• Business grows significantly during the course of the marriage

• Both family attorneys agree to retain one valuation expert to determine the value of the entity as of today

• Expert prepares a valuation report and concludes that business is currently worth $5,000,000

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Conflicting Arguments

• Business owner argues that business was received by gift or inheritance (or was owned before the marriage) and is thus separate property not subject to an equitable interest

• Spouse argues that most of the growth occurred during the course of the marriage and thus she is entitled to her/his equitable share

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Opposing Arguments • If owner of the business never worked in the

company, had absolutely nothing to do with the company’s growth, and continued to hold the investment in a separate account-it would appear that the growth was the result of “market forces” and he/she may prevail

• On the other hand, if the owner was the “rain maker” for this company, and the growth in the company was the direct result of “his/her efforts” that occurred during the course of the marriage, it would appear that the spouse may prevail

• See Halpern v. Halpern, 352 SE 2nd, 753

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What if Our Facts Are Somewhat in the Middle?

• Business Owner Worked in the business • Business Owner worked in the business, but

was one of a few individuals that created the increase in growth

• Business owner worked in the business, maintained an administrative position, and was paid a reasonable salary

• Business owner worked in the business, held a sales position, brought in new clients, but was clearly not “The Rainmaker”

46

Active v. Passive Appreciation • See Mayhew v. Mayhew, 205 W. Va. 490 (1990) where

the Supreme Court of West Virginia applies a five step test

• “Active participation of separate property of either of the parties to a marriage, or that increase which ‘results from

** (A) an expenditure of funds which are marital property…or

** (B) work performed by either or both of the parties during the marriage

is marital property which is subject to equitable distribution”

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“One of Five”

• See Decker v. Decker, 435 SE 2nd 407 where a Virginia court found that “20% of appreciation was attributable to Mr. Decker…He was one of five key executives, but the ‘first among equals’

• Court pointed out that there was a $10 million life insurance policy on Mr. Decker’s life owned by the corporation, and no other executive was insured for more than $3 million

48

“One of Four” • See Herron v. Herron, 2004 Ohio 5765 - Ohio: Court of

Appeals, 3rd Appellate Dist. 2004 • An Ohio Court of Appeals defined “passive income as

income acquired as a result of the labor, monetary, or in-kind contribution of either spouse…there was extensive testimony that Ms. Herron was one of four key executives running the company, that the complexity of her position increased as the company grew, her participation allowed her brothers to focus on their areas…the Court found Ms. Herron personally contributed to 25% of the overall growth of the company.”

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One of the Rainmakers

• See Ellis v. Ellis, 235 AD 2d 1002 where the New York Appellate Division found that “since Mr. Ellis personally generated 20% of total sales, 20% of the total appreciation of his stock constituted marital property”

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How may an expert help? If your client is not the only person generating Sales:

• analyze volume of sales over the last few years by sales person • analyze gross profit margins on each sales person’s accounts • review the financial statements and FOOTNOTES- • review Board of Directors minutes for additional insights • interview the company’s independent CPA • what if the owner is being paid a reasonable salary or an amount in

excess? Has the spouse already received her equitable share during the marriage?

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Presenter

Martin S. Varon Alternative Resolution Methods, Inc.

Smyrna, GA


WHAT IS THE DOUBLE DIP?

53

Let’s assume the cash flow generated from spouse’s closely

held business is as follows:

54

Sales Less: Cost of Goods Gross Profit Less: Operating Expenses Less: Owner’s Salary Net Income/Net Cash Flow

Income Statement

55

$2,000,000 ($1,200,000)

$800,000

($50,000) ($750,000)

$0

Owner of the business claims there is very little if any value because the company is not

generating any cash flow

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•Valuation Expert analyzes subject company and concludes that owner is paying him/herself an excessive (unreasonable) salary * Expert analyzes compensation data bases for subject industry, size of this company, and geographical location of this company * Expert concludes that if the owner sold his/her company to a hypothetical willing and able buyer in an arm’s length transaction, he/she will have to hire someone to do the ex-owner’s job * Based upon the appropriate data bases, expert concludes that a reasonable salary for this job is $400,000 * Valuation expert restructures the net cash flow analysis as follows:

Valuation Expert’s Findings

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Sales Less: Cost of Goods Gross Profit Less: Operating Expenses Less: Salary for Owner’s Job Net Income/Net Cash Flow

Income Statement-As Reported & As Revised

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As Reported $2,000,000 ($1,200,000)

$800,000 ($50,000) ($750,000)

$0

As Revised $2,000,000 ($1,200,000)

$800,000 ($50,000) ($400,000) $350,000

Conclusion of Value • Valuation Expert Analyzes the cash flow being

generated from subject company • The expert concludes that the income approach

is the major approach to determine the fair market value of subject company

• Expert determines the appropriate capitalization rate for subject company

• Capitalization rate is based upon numerous factors including US Treasury Bill rate, equity factors, size of subject company, industry of subject company, and any specific factors unique to this company

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Conclusion of Value • Net cash flow is divided by the capitalization rate

to determine the value of subject company • Another way to look at this: the value of the

company times the capitalization (interest) rate results in the net cash flow

• A $1,000,000 bank account that pays us 5% interest is generating $50,000 of interest income

• Isn’t this the same as stating that an account generating $50,000 of interest income/cash flow with a 5% interest (capitalization) rate is worth $1,000,000 because $50,000 divided by 5% is $1,000,000?

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Business Owner’s Argument

• Owner argues that business is generating no net cash flow because profits are being paid to him/her in the form of a $750,000 salary

• Owner argues that since the business has no value, there is no property settlement

• Owner agrees that (deductible) rehabilitative alimony should be awarded based upon his $750,000 salary

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Conclusion of Value

• Expert concludes that this entity is generating $350,000 of net cash flow and is worth $1,400,000

• Court accepts the expert’s findings • Court rules that spouse is entitled to a

50% equitable distribution and orders business owner to pay your client a $700,000 non taxable property settlement

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• Property Settlement determination was based upon the cash flow being generated over and above the owner’s reasonable compensation level (the $350,000 net cash flow over and above a reasonable salary of $400,000)

• Court determines that alimony and support should be based upon owner’s $750,000 actual W-2 earnings

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• Isn’t owner being asked to pay a property settlement, alimony, and child support on the same amount of cash flow

• Isn’t owner being hit two times off the same income/cash flow

• This is commonly referred to as the “DOUBLE DIP”

• Is this a fair/equitable result?

64

Spousal Support Considerations in the Context of a Business Valuation

Sarah McCormack Kessler & Solomiany LLC

Atlanta, GA


65

THE DOUBLE-DIPPING PROBLEM

• Only arises in a context in which business valuation method being used is the income approach

‒ Under this method, future income stream is reduced to present value and added into the value of the business.

‒ Cf. asset approach (tangible plus intangible assets less liabilities = value)

‒ Cf. market approach (value based upon sales of similar business)

66

WHAT IS THE PROBLEM, EXACTLY? • The same future income that is added back into the value of the

business, which is then equitably divided, is the source of funds for future alimony payments.

• SO: the payee spouse gets paid twice:

1) His / her share of the value of the business, the number for which is increased by the future income stream; and

2) His / her alimony package that is paid out of future income

stream generated by the business.

• Jurisidictions are divided as to whether this is, in fact a problem.

67

Steneken v. Steneken, 873 A.2d 501 (2005): CLASSIC EXAMPLE OF COURT-APPROVED DOUBLE-DIP

• Relevant facts:

– Husband owned a closely held business (sole shareholder and operator).

– Trial court accepted wife’s valuation expert’s findings.

– That valuation expert used an income approach.

* As part of his analysis, he determined that the husband paid himself an excessive salary.

* The expert “normalized” that salary (i.e., brought it within reasonable salary parameters) in determining how much of salary was a permissible business expense that could be deducted from the overall business value.

* The excess salary, in other words, was brought back and included in the value

of the business.

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Steneken continued: “Normalized Salary” and Sweet Revenge

• At the initial trial court level, the trial court did this:

1) Included only the husband’s excess salary in the business value (having excluded the normalized salary as a business expense); and

2) Used the normalized salary as the basis for income out of which to pay spousal support.

__________________________________________________________________________

• Wife appealed.

• The appellate court, in an unexpected turn, agreed that alimony was too low in that it should have been calculated based upon EXCESSIVE salary versus REASONABLE salary.

• On remand, the trial court increased the alimony award on this basis. Now Husband appealed.

• The NJ Supreme Court upheld the double-dip.

• WHY??????? You may ask . . . . .

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The Steneken Rationalization • NJ’s alimony statute and equitable distribution statute did

not track each other, but rather were based upon different factors

• How much alimony is awarded should not be contingent upon what valuation approach the trial court deems is best

• “[T]he final judicial inquiry is plainly put: whether the ultimate result, both in its whole as well as in its constituent parts, is fair under the circumstances and congruent with the standards set forth in the [NJ alimony and equitable distribution statutes].”

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Ms. Steneken at the end of seven years of litigation:

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Is the Double Dip Always Inequitable?

• Maybe a back-door way of awarding, in effect, a greater share of a business asset (once as equitable division, then as alimony).

• Probably best practice is always to keep it “clean,” and to “call a spade a spade.”

• Ask for greater business share buy-out, or more alimony . . . . as the facts of the case and your client’s interests may warrant . . . . ‒ Minimize need of the payee spouse through equitable division (find liquidity to get him

or her a paid-off house, paid-off car, etc.)

‒ As an off-set to payee spouse receiving more of the “other” assets, leave fair share of business (if not greater share of business) in payor spouse’s hands

‒ Create alimony package based on decreased needs for cash and with goal of avoiding double-dip

• Certainly this approach is likely to result in less trouble / expense / appeal(s) for your client. • NOTE: most jurisdictions, if not all, do not worry about double dip in the context of child

support, the rationalization being that the welfare of a child is the paramount concern

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The Double Dip in the Context of a Divisible Professional License • As we know, a professional license is considered to be a divisible marital

asset in certain states.

• Some of those states recognize a “merger” doctrine under which the professional license, at some point, merges with the professional practice’s value (i.e., has no independent value).

• Probably assigning an independent value / income stream to a

professional license is most useful as an exercise when one divorcing spouse is in the fledgling stages of his or her professional career, and the other divorcing spouse effectively carried him or her through school.

• In this scenario, the professional practice would not have a limited value,

but the professional license would have a long, as-yet-unrealized “life.”

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From Grunfeld v. Grunfeld, 731 N.E.2d 142, 147 (NY 2000):

“Where the license is likely to retain its value in the future but the nonlicensed spouse may only be entitled to receive maintenance for a short period of time, it may be fairer actually to distribute the value of the license as marital property rather than to take the license income into consideration in determining the licensed spouse’s capacity to pay maintenance.”

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To Dip or Double Dip – That is the Question

At least one NY court distinguished the value of a professional license from the value of a business by saying that the professional license was an “intangible” asset and that the business was a “tangible” asset. There was, therefore, no double-dipping if spousal support paid out of this “intangible” asset versus the “tangible” one.

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THE PERSONAL GOODWILL PROBLEM

• The majority rule across jurisdictions is that personal goodwill, versus enterprise goodwill, in a business is non-divisible and / or excludible from the marital estate.

• Can this personal goodwill enhance a party’s spousal claim?

• The answer should be . . . .

YES

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Problem-Solving • If personal goodwill is not divisible as a marital asset, exclude its value

from the business value, but then ask to be made whole through alimony.

• Value of personal goodwill is sometimes calculated based upon a particular professional earning more than the average reasonable salary for comparable professionals in his or her community – the excess represents his or her special, non-marketable skill set.

• NOTE: this is different from the “excess” salary that is used, in an income approach analysis, to artificially reduce business value as a business expense

• This higher-than-average, personality-enhanced salary is why you should argue that there is an “enhanced” alimony claim (because this excess is excludible from the marital estate/ has enhanced the parties’ lifestyle during the marriage) – i.e., the payor should pay more than what the average Joe in his or her profession should pay.

77

If you keep these spousal support considerations

in mind in a divorce involving a business, your clients won’t feel like this . . . .

78

Business Valuation Case Update

Sarah McCormack Kessler & Solomiany, LLC

Atlanta, Georgia 404-688-8810

[email protected]

79

The One Everyone Is Talking About: Adams v. Adams, 945 N.E.2d 844 (2011)

Case illustrating the difference in how to approach projected future income stream where dealing with corporation (infinite life) versus partnership (limited to individual’s remaining partnership years) . . . . APPLICATION: income approach valuation.

80

Relevant Adams Facts:

• Husband was a partner in a large, successful investment fund partnership.

• Special master appointed by the court valued his partnership interest through income approach – result:

$81M partnership interest value included in the marital estate!!!

• Part of special master’s analysis involved reducing husband’s future benefits of partnership to present value.

• Upon appeal, husband argued:

1) Partnership interest too speculative to be included in the marital estate; and

2) Present value of his future partnership benefits was too high.

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The Supreme Court Judicial Court of Massachusetts rejected the first argument but agreed with the second:

“[W]e hold that a divorcing spouse’s interest in a partnership that produces a consistent stream of profits, and reliably disburses those profits to the partner spouse over a period long enough to appraise the present value of the partnership interest fairly, is, in the discretion of the judge, assignable to the marital estate if its inclusion would achieve a fair financial settlement.”

BUT: They then went on to hold that the special master should have used a discounted cash flow methodology versus a direct capitalization of income approach because the latter “assumes a perpetual stream of income” that is true of a corporation BUT NOT TRUE of an individual’s participation in a partnership.

NOTE: assuming perpetual life results in an artificially higher present value.

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OTHER NOTABLE RECENT CASES ON BUSINESS VALUATION (I.E., WITHIN THE PAST YEAR, PUBLISHED OPINIONS)

• Connecticut

McRae v. McRae, 129 Conn. App. 171 (2011) (upholding inclusion of check paid toward ongoing project in asset approach to business valuation, as well as alimony award [no income approach, so no double dip argument made])

• Massachusetts (other than Adams)

Caveney v. Caveney, 81 Mass. App. Ct. 102 (2012) (trial court could use asset approach versus income approach to value business – marketability discount and minority share discount should not be applied, however, where no imminent sale of a closely held business)

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• North Carolina

Williamson v. Williamson, 719 S.E.2d 628 (2011) (court not bound to use any particular valuation method, so long as method chosen is sound – here, appellate court cannot tell how value reached, so remanded for clarification / reconsideration) Quesinberry v. Quesinberry, 709 S.E.2d 367 (2011) (trial court business value will be upheld if sound methodology – where no remaining assets, and no evidence of any other good will, other than perhaps simple name recognition, okay to assign business a $0 value and award to wife)

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• North Dakota

Nuveen v. Nuveen, 795 N.W.2d 308 (2011) (upholding income approach to valuation of orthodontic practice and calculation of spousal support; no double dip argument made)

• Oregon

Hanscam v. Hanscam, 247 Or. App. 207 (2011) (if no value to business beyond assets, and no covenant not to compete – no goodwill that should be included in business value)

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• Oregon cont.

Rodenbeck v. Rodenbeck, 246 Or. App. 449 (2011) (not permissible to discount buy-out amount paid to wife for her share of business in an amount representing the taxes that husband would have to pay on income used to effectuate that buy-out) NOTE: business valuations are often “tax-affected,” but there the tax on the BUSINESS is taken into account, not the tax on the INCOME stream used to buy out the business

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• Wisconsin

McReath v. McReath, 335 Wis.2d 643 (2011) (saleable good will, whether personal or enterprise, is properly includible in marital estate; rejects double dip argument in spousal support context because asset can either be sold for full value OR can be retained, continue to produce income, and then later be sold – still for full value) NOTE: appeared to be a case of first impression on the goodwill issue.

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Documents

Divorce and Business Valuationsmedia.straffordpub.com/products/divorce-and-business-valuations-2… · 15/03/2012 · Divorce and Business Valuations Navigating Complex Valuation