Divorce and Business Valuations Navigating Complex Valuation Issues - - PowerPoint PPT Presentation

Divorce and Business Valuations

Navigating Complex Valuation Issues and Methodologies and Analyzing Valuation Impact on Support

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THURS DAY, MARCH 15, 2012

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

Gunnar J. Git lin, At t y, The Gitlin Law Firm, Woodst ock, Ill. Mart in S . Varon, Principal, Alternative Resolution Methods, At lant a S arah McCormack, Part ner, Kessler & Solomiany, At lant a Daniel E. Clement , At t y, Clement Law, New Y

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VALUATION DISCOUNTS AND ENTERPRISE VERSUS PERSONAL GOODWILL

Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL 815-338-9401 gjg@gitlinlawfirm.com 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

7 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

Key Concept is relationship between nature of ownership interest from marketable, controlling interest to non- controlling, non-marketable interest upon valuation discount.

10 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

STRATEGIC VALUE CONTROL VALUE FREELY TRADED VALUE OR MARKETABLE, 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 to control values via strategic premium Obtain indirectly by reference to freely traded values via control premium Obtain indirectly by reference to control values via lack of control discount Obtain indirectly by reference to freely traded values via lack of marketability discount

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

11 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

Type of Ownership Interest

Example

Valuation Premium / Discount Illustrative Premium / Discount % Illustrative Impact

• n 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

• r 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

12 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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.

13 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 “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).

14 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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.

15 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com



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

• n 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.

16 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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

17 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

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.

18 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

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%

19 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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

20 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 Normalization process may include two types

• f 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

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

• f 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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.

31 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 The Bible:

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

 BVR’s Guide to Discounts for Lack of

Marketability, 2009:

34 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 Many States: Personal Goodwill Not a

Marital Asset:

 See:

http://www.bvresources.com/FreeDownloads/Good willhunting.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.

35 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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.

36 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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

37 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

 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 Gunnar J. Gitlin, Gitlin Law Firm, Woodstock, IL: www.GitlinLawFirm.com

Presenter

Martin S. Varon Alternative Resolution Methods, Inc. Smyrna, GA 770-801-7292 mvaron@armvaluations.com

39

Acquiring business through gift, inheritance, or reorganization

40

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

41

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

42

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

43

Conflicting Arguments

• Business owner argues that business was

received by gift or inheritance (or was

• wned before the marriage) and is thus

separate property not subject to an equitable interest

• Spouse argues that most of the growth
• ccurred during the course of the marriage

and thus she is entitled to her/his equitable share

44

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

45

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”

47

“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.”

49

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%

• f total sales, 20% of the total appreciation
• f his stock constituted marital property”

50

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?

51

Presenter

Martin S. Varon Alternative Resolution Methods, Inc. Smyrna, GA 770-801-7292 mvaron@armvaluations.com

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

56

• 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

57

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

58

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

59

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?

60

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

61

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

62

• Property Settlement determination was

based upon the cash flow being generated

• ver 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

63

• 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 404-688-8810 smccormack@ksfamilylaw.com

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

• f the business.

68

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 . . . . .

69

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].”

70

• Ms. Steneken at the end of seven

years of litigation:

71

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

• r 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

• ther 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

• ut 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 /

• r 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.

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If you keep these spousal support considerations in mind in a divorce involving a business, your clients won’t feel like this . . . .

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Business Valuation Case Update

Sarah McCormack Kessler & Solomiany, LLC Atlanta, Georgia 404-688-8810 smccormack@ksfamilylaw.com

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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.

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

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

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

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

• 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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COMING SOON . . . .

New law from excellent practitioners such as yourselves . . . .

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