what family lawyers need to know about business valuation in divorce - presentation to the memphis...

What Family Lawyers Need to Know

About Business Valuations in Divorce

Presented by:

Robert Vance, CPA, ABV, CFF, CVA,

CFP

Forensic & Valuation Services, PLC

901-507-9173

www.ForensicVal.com

[email protected]

What is the Essence of a Business Valuation?

It‟s a formula – right?

What is the Essence of a Business Valuation?

Estimation of two primary components

1) The future expected benefits

2) The risk related to receiving those future expected benefits

A valuation measures the:

Present Value of the future benefits (e.g. The Time Value of Money; a dollar today is worth more than a dollar in one year)

A business is only really worth the present value of the cash flow over and above a “normal” owner compensation

What are the Standards of Value?

Fair Market Value

Fair Value

Investment Value

Intrinsic (Fundamental) Value

Book Value

Divorce Value?

Fair Market Value

Definition per IRS Revenue Ruling 59-60

“The price at which a property would change

hands between a willing buyer and a willing

seller when the former is not under any

compulsion to buy and the latter is not under any

compulsion to sell and both parties have

reasonable knowledge of the relevant facts.”

Fair Market Value

Powell v. Powell1

1) Fair Market Value Standard as in IRS Rev. Rul. 59-

60 does not have to be strictly followed when

valuing a business in a divorce

2) Business owners can be held to values in personal

financial statements submitted to banks

3) Credentials and experience of business valuation

analysts are critical

1. Powell v. Powell, 124 S.W.3d 100 (Tn. Ct. App. 2003)

What are the Approaches to Valuation?

Blasingame v. American Materials, Inc.2

“There are a number of acceptable methods available to

determine the value of a corporation.” Blasingame

recognized three of these methods [approaches]:

1) Market Value [approach],

2) Asset Value [approach], and

3) Earnings Value or Capitalization of Earnings

[Income] [approach]

2. Blasingame v. American Materials, Inc., 654 S.W.2d 659, (Tenn. 1983)


1) Market Approach

a) Expected benefit = some level of earnings (reve-

nue, net income, EBITDA, gross profit, etc.)

b) Expected risk and growth are measured by a

market multiple (P/E, MVIC/EBITDA, etc.)

c) Market multiples are obtained from public com-

panies, from sales of similar companies, or prior

sale of the subject company or interests in the

subject company

Beware of this value as it may or may not include Goodwill and may not include

all assets like cash and liabilities like A/P

Market Transaction Method Using The Goodwill Registry

Total Value

Gross Revenues-2010 900,000 Estimate for 2011

Goodwill Registry Average Price/Rev %-General Dentistry 65.1% Average

Indicated Selling Price - Includes Equipment 585,900

Adjusted Net Operating Assets 158,660 Cash, A/R, Payables

L-T Debt (213,348)

531,212

Non-Operating Assets

Destin Condo 450,000

Excess Cash 10,000

Residential Lot 15,000 475,000

Indicated Total Value, Net of Debt 1,006,212

Indicated Total Value, Net of Debt (Original) 1,006,212

Total Goodwill Value

Gross Revenues-2010 900,000

Goodwill Registry Average GW/Gross Revenues %-General Dentistry 49.0%

Indicated Goodwill Included in Selling Price 441,000

* General Dentistry; Year 2010; The Health Care Group, Inc.


2) Asset Approach

Adjusted Net Book Value method is similar to the

classic accounting formula:

Assets - Liabilities = Equity

or

Identifiable “Hard”* Assets Adjusted to FMV –

Liabilities = Value

* “Hard Assets”: Cash, A/R, N/R, WIP, Patient

Records, Equipment, Purchased Goodwill, etc.

Adjusted Net Asset Value Method

3/31/2011 3/31/2011

Bal. Sheet Adjustments Bal. Sheet

Cash 98,408 98,408

Accounts Receivable 63,215 (20,000) 1) 43,215

Accounts Payable & Other (2,963) (2,963)

Adjusted Net Operating Assets 158,660 138,660

Dental Equipment (Depreciated) 50,000 150,000 2) 200,000

Non-operating Assets 0 475,000 3) 475,000

Total Asset Value 208,660 813,660

L-T Debt (213,348) (213,348)

Indicated Value, Net of Debt (4,688) 600,312

1) Insurance company discount - A/R recorded at gross before discounts

2) Appraisal of dental equipment by personal property appraiser

3) Appraisal of other assets by personal property appraiser & real estate appraiser


3) Income Approach

a) Expected benefit = net cash flow or other

measure of:

Forecasted benefits

Normalized historical benefits

b) Expected risk is measured by the weighted

average cost of capital, capitalization rate or

discount rate

c) Net present value of expected benefit

Capitalization Of Earnings Capitalization Rate

Risk-free Rate of Return 4.5% 5 Year Average of 20 Yr Bond rate

Common Stock Equity Risk Premium 6.5% Morningstar, Ibbotson SBBI 2010 Valuation Yearbook

Small Stock Risk Premium 10.5% Morningstar, Ibbotson SBBI 2010 Valuation Yearbook

Company Specific Premium 6.5% Independent Analysis

Net discount rate 28.0%

Less Sustainable Growth 3.0% Independent Analysis

Next Year Capitalization Rate 25.0%

Capitalization Of Earnings Economic Stream

Dec Dec Dec Dec Dec

2011 2010 2009 2008 2007

Historic Net Income Using Sched. C as Basis 516,036 422,003 330,484 191,134 60,503

Depreciation 0 17,957 33,992 69,649 119,004

Mean Compensation for Independent Dentists* (211,006) (209,733) (208,468) (207,210) (205,960)

Adjusted Earnings Before Deprec. and Taxes 305,030 230,227 156,008 53,573 (26,453)

Weight 3 2 1 0 0

Stream Weight 915,091 460,454 156,008 0 0

Weighted Average 255,259

Less Ongoing Depreciation/Amort. (38,000)

Taxable Base 217,259

Less State Income Taxes 6.5% (14,122)

Sub-Total 231,381

Less Federal Taxes (73,489)

Sub-Total 157,892

Add Back Ongoing Depreciation/Amort. 38,000

Decrease/(Increase) in Working Capital (5,000)

Decrease/(Increase) in Capital Expenditures (38,000)

Ongoing Earning Capacity 152,892

* American Dental Association, 2009 Survey of Dental Practice; 2008-2006 reported; 2011-2009

calculated with trend %

Capitalization Of Earnings Indicated Value

Ongoing Capacity 152,892

Capitalization Rate 28.5%

Operating Value 536,464

Non-Operating Assets

Destin Condo 450,000

Excess Cash 10,000

Residential Lot 15,000 475,000

Indicated Value, Net of Debt 1,011,464

Indicated Value, Net of Debt (Original) 1,099,050

1/.285 =

3.5 Multiple

How is Personal Goodwill Handled in a Tennessee

Divorce?

Generally

1) Fair Market Value inherently includes Goodwill

when valuing with a going concern premise

2) Personal goodwill is generally not to be considered

in valuation of professional practices and

small, closely-held businesses primarily dependant

upon the individual for success

3) Courts often use a standard other than FMV


Divorce?

Hazard v. Hazard3

1) Dr. Hazard‟s practice was highly specialized and

very dependent upon referrals from other physicians

2) Court rejected gross income approach to value

Husband‟s medical practice

3) Goodwill in a professional practice is not a marital

asset subject to equitable distribution

3. Hazard v. Hazard, 833 S.W.2d 911 (Tn. Ct. App. 1991)


Divorce?

Hazard v. Hazard (cont’d)

4) Sole practitioner professional practice is to be

valued using the “net tangible assets with

ascertainable value.” Cites Smith v. Smith4

5) Net Asset Value a.k.a. Net Book Value

4. Smith v. Smith, 709 S.W.2d (Tn. Ct. App. 1985)

How is Enterprise/Business Goodwill Handled in a

Tennessee Divorce?

Witt v. Witt5

1) If the professional practice or closely-held business

is large and diverse enough and not solely dependent

on the individual, goodwill may be considered as

part of the ownership interest

2) Dr. Witt‟s clinic was found to have separate good-

will that was not directly related to his professional

or personal goodwill

5. Witt v. Witt, 17 TAM 15-6 (Tn. Ct. App. 1992)


Tennessee Divorce?

Eberting v. Eberting6

1) Orthodontia practice value at FMV by Vance at

$700k; included Enterprise (not Personal) Goodwill

2) Opposing expert valued practice At $224k (net book

value with no Goodwill)

3) Trial judge found value to be $500k, which was a

value indicated by the owner; judge knew that any

value north of $224k was including Goodwill

6. 2012 WL605512


Tennessee Divorce?

Eberting v. Eberting (cont’d)

4) “When asked if the amount of goodwill were

subtracted from his $700,000 if the resulting value

would be $270,000, Mr. Vance stated: „That‟s

correct, if you went with a net asset value method,

which of course is not the real value of this

company.” Mr. Vance also stated: “If you were to

strike the personal goodwill, this clearly has

enterprise goodwill associated with it. It‟s not all

personal to him.‟ ”


Tennessee Divorce?


5) “Husband argues on appeal that the value assigned

by Wife‟s expert, Mr. Vance, of $700,000 should

not have been accepted by the Trial Court because it

incorrectly included good will. We agree that

“professional good will is not a marital asset which

would be accounted for in making an equitable

distribution of the marital estate.” Smith v.

Smith, 709 S.W.2d 588, 592 (Tenn. Ct. App. 1985).”


Tennessee Divorce?


6) “A trial judge, as the fact finder, is not required to

check his or her common sense at the door when

considering evidence. The Trial Court had before it

evidence of values that Husband himself had

applied to his practice, and had Husband‟s own

testimony that he would be upset if he were to sell

the practice and receive only the value assigned by

his expert. The Trial Court found a value for the

practice that was within the range of values

presented by the evidence.” [emphasis added]

Importance Existence Mult.

Personal Goodwill Attributes Utility Utility Utility Percent

Ability, Skill & Judgment 1 4 4 16 9.2%

Lacks Transferability 2 5 0 0 0.0%

Age & Health 3 5 1 5 2.9%

Personal Staff 4 4 2 8 4.6%

Personal Reputation 5 4 3 12 6.9%

Personalized Name 6 4 3 12 6.9%

Marketing & Branding 7 2 2 4 2.3%

In-bound Personal Referrals 8 4 2 8 4.6%

Knowledge of End User/Customer 9 2 2 4 2.3%

Important Personal Nature 10 3 2 6 3.5%

Total Personal Utilities 37 21

Total Personal Multiplicative Utility 75 43.4%

ImportanceExistenceMultiplicative

Enterprise Goodwill Attributes Utility Utility Utility Percent

Enterprise Staff 1 4 3 12 6.9%

Business Reputation 2 4 3 12 6.9%

Business Name 3 5 2 10 5.8%

Marketing & Branding 4 3 2 6 3.5%

Business Locations 5 4 3 12 6.9%

Years in Business 6 4 3 12 6.9%

Systems & Organization 7 3 2 6 3.5%

Out-bound Referrals 8 4 2 8 4.6%

Repeating Revenue Stream 9 5 4 20 11.6%

Total Enterprise Utilities 36 24

Total Enterprise Multiplicative Utility 98 56.6%

Total Multiplicative Utility 173 100.0%

Multiattribute Utility Model (MUM)*

*Wood, David, BVR‟s Guide to Personal v. Enterprise Goodwill, Business

Valuation Resources, LLC, Portland OR, 2010.

How are Buy-Sell Agreements Handled in a

Tennessee Divorce?

Harmon v. Harmon7

1) Dr. Harmon was a doc in a large medical practice

2) Buy-sell agreement contained an artificially low

value formula if a doc terminated

3) Buy-sell agreement of a closely-held corporation, not

signed by the non-shareholder spouse, is not binding

on that spouse and is only a consideration in the

valuation

7. Harmon v. Harmon, 25 TAM 15-22 (Tn. Ct. App. 2000)

How are Buy-Sell Agreements Handled in a

Tennessee Divorce?

Inzer v. Inzer8

1) Husband owned a 24% interest in a Sonic restaurant and signed a buy/sell agreement with a low valuation method

2) Wife, not an owner, signed an agreement stating she agreed to be bound by the same terms

3) Court found that the value of the business should be determined based upon the buy/sell agreement since the wife had signed the agreement

8. Inzer v. Inzer, No. M2008-00222-COA-R3-CV July 28, 2009 (Tenn.Ct.App. 2009)

Financial Statement Adjustments

1) Adjustments for Generally Accepted

Accounting Principles (“GAAP”) departures

a) Year end accruals

b) Accelerated depreciation

c) Cash basis to accrual (inventory, accounts

receivable)

d) Prepaid assets

e) Intangibles (work in process, medical files)

Financial Statement Adjustments

2) Adjustments for Normalization

a) Personal expenses

b) Owner‟s salary

c) Non-operating assets

d) Shareholder loans

e) Nonrecurring income and expenses

f) Income taxes

Discounts & Premiums

1) Discount for Lack of Control (Minority Interest)

2) Premium for Control

3) Discount for Lack of Marketability

4) Discount for Key person

They depend on the interest to be valued and the

techniques used to establish the value conclusion


1) Discount for Lack of Control (Minority Interest)

Anderson v. Anderson9

“The reasons given by Warren to discount the value of the husband‟s minority interest are persuasive, and the evidence does not preponderate against discounting the value by 38.3%.”

9. Anderson v. Anderson, 2006 WL 2535393, at*4


3) Discount for Lack of Marketability

Bertuca v. Bertuca10

“There is no indication in the record that Mr. Bertuca

has any intention of selling his interest in Capital Food

Services. Thus the value of the business is not affected

by the lack of marketability and discounting the value

for non-marketability in such a situation would be

improper.” Anderson, 2006 WL 2535393, at*4.

10. Bertuca v. Bertuca, 2007 WL 3379668 (Tenn.Ct.App.).

what family lawyers need to know about business valuation in divorce - presentation to the memphis...

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