Business ownership interests can be a central item of contention in divorce cases. Oftentimes, the values of other assets are much clearer, assuming all parties have knowledge of their existence. The value of privately held business interests are usually not as cut and dry. It can be the case that the same business is valued differently by two separate qualified appraisers given the same information at the same time. This fact alone lends itself to the potential for disputes to arise. There are a number of factors in the mix in a marital dissolution case from a business valuation standpoint. A few of these issues are explored below.
Standard of Value & Use of Discounts – The standard of value is dependent upon jurisdiction. State law dictates the standard of value in the courtroom and case precedent often comes into play. Some jurisdictions have adopted the fair market value standard, while others operate in the fair value world. The primary difference generally relates to the use of a discount for lack of marketability and a discount for lack of control. There are other discounts that can be included depending on the facts and circumstances, such as a key man discount or built-in gains discount. Fair value jurisdictions generally do not allow valuators to use discounts when coming to a conclusion of value. A firm grasp on the standard of value is the first step in any valuation engagement, but becomes essential in a divorce litigation setting given the dependence of jurisdiction.
Valuation Approaches/Methods – This issue also leans heavily on jurisdiction. Prior cases can give insight into what approaches and methods are deemed satisfactory. Valuators must be cognizant of the use of projections in a discounted cash flow model as it is not accepted in some courtrooms. Additionally, the guideline public company approach may be inappropriate if the divorce case involves a small, privately held business. Knowledge of what is acceptable in the specific jurisdiction is imperative for the valuator.
Personal vs. Enterprise Goodwill – Personal goodwill issues can flare up in the case of professional service companies that rely heavily on the reputation of a specific individual. Companies such as financial advisors, accountants, lawyers, doctors, and dentists can have goodwill issues in a divorce matter. These businesses are often named after a specific individual or groups of individuals, making it difficult to separate the person from the business. The key point of contention comes down to the split between personal and enterprise goodwill in the company. Is the goodwill attributed to the person or to the business operations? Oftentimes, a multi-attribute utility model can be helpful in determining how much of the business’ goodwill to allocate to the individual. This model attempts to quantify factors that are more qualitative in nature based on their importance and reliance on the specific individual. The separation of goodwill can become a significant issue in that enterprise goodwill can be split, while the individual is able to keep the entire value allocated to his/her personal goodwill.
These are just a sampling of a few key issues in the valuation space as it pertains to divorce litigation. There are a number of other valuation and non-valuation related matters that can impact divorce cases that will be addressed in a future blog post. Stay tuned!