June / July 2017 : Expediting the Business/Professional Practice Valuation Process

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

When a business or professional practice is involved in a divorce, there is often considerable difficulty and expense in determining a settlement value acceptable to both parties. This frequently is a major impediment to reaching settlement.

The fees to value a business or professional practice – and time required – can be significant, especially if two – or three – valuation experts are involved.

The following presents two methods to facilitate resolution of the valuation issue on a cost-effective, expeditious basis.

Abbreviated valuation analysis for mediation and/or settlement negotiations is often effective at providing a reliable value without “going the whole 9 yards” on the valuation process.

Essentially the business valuation expert performs a sufficient level of analysis to enable him/her to provide a reliable estimate of value–or range of values–for settlement purposes. The expert will provide well-footnoted valuation schedules and a summary report if requested.

The expert will generally be available for mediation to explain the valuation analysis.

The expert could be a “neutral” working on behalf of both parties; or, each party may hire an expert to perform an abbreviated valuation analysis. If the case is not resolved at mediation, the expert(s) can perform a more comprehensive analysis and report letter for trial or arbitration – generally with no duplication of effort.

Not all businesses are suitable for this approach. Some have too much uncertainty about the future such that an in depth analysis is required. However, based on the author’s experience, the abbreviated valuation approach applies to the vast majority of companies and professional practices.

If effective, this approach saves time and fees. The cost is generally about half the fee for a comprehensive valuation analysis and report.

Use of a neutral appraiser working on behalf of both parties is often an effective method for resolving the valuation issue on an expeditious, cost-effective manner.

It is common for each party to retain a business valuation expert. But, it is not uncommon that the values calculated by such experts are meaningfully different. If they cannot resolve the disparity in values, often a third expert is engaged to opine on value–causing considerable delay and additional fees.

However, if the parties can agree on one business appraiser at the outset, they can avoid the possible “battle of experts”. They can also save time, fees and emotion. Experienced family law practitioners know and can usually agree on a business appraiser with a reputation for competence and integrity.

When using a neutral, it is often advisable to reserve the right to have his/her valuation analysis reviewed for reasonableness by another expert. This offers some protection against a valuation analysis performed erroneously by the neutral. But, to preserve the benefits of using a neutral, the review should be limited to a “reasonableness check,” not a full-blown valuation analysis.

Example

(see PDF below for example details)
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Continued in PDF file below… “Expediting the Business/Professional Practice Valuation Process”
View / Download June 2017 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

May 2017 : Valuing a Small Minority Interest in a Large Personal Services Firm

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

In recent columns (October 2016 and March 2017), various aspects of using “value to the owner,” sometimes referred to as “Holder’s Interest” value, were presented.

Background

As noted in the October column, the Michigan Court of Appeals has ruled in a number of cases that if a business providing personal services is worth more to the owner than the price at which it could be sold, the value for divorce purposes is value to the owner, unless there is reason to believe the enterprise will be sold. Kowalesky v. Kowalesky, 148 Mich App 151; 384 NW2d 112 (1986), and several other Court of Appeals (COA) cases cited in the column.

As noted in the March column, the underlying logic is as follows:

If there is no intent to sell or discontinue a business or professional practice, it should be valued for divorce based on its intrinsic value to the owner on a going concern basis. The financial benefits from that value are what have been conferred on the family while intact and will be conferred solely on the owner post-divorce.

If there is no intent to sell, under what rationale should any value other than the value based on current financial benefits provided by the enterprise be used in a divorce settlement?

No other value is relevant to this family or, hence, to this divorce.

Application to Small Minority Interest in a Large Firm

There are many large law firms, accounting firms, engineering firms, medical practices, etc. operating in Michigan. How is the “value to the owner” determined for a member holding a minority interest in such an enterprise?

Binding “Buy/Sell” Agreements Generally Not Applicable

Most large personal service firms require individual members to sign binding agreements providing (1) restrictions on transfer and (2) a set price or formula to determine the price of a member’s interest on termination. Quite often such prices include no goodwill value.

It is well established that such agreements are not determinative of value for divorce because none of the events to which they apply–death, disability, or termination of interest for other reasons–are occurring.

Valuing Entire Firm and Applying Member’s Ownership Percentage Is Generally Not Representative of Value

For example, assume two partners—A and B—work at a large accounting rm. Both own 1% of the practice. But, A makes $500,000 annually while B makes $300,000. This disparity is due to different performance levels which may ultimately result in A being awarded a higher ownership interest than B, but currently they both own 1%.
……

Continued in PDF file below… “Valuing a Small Minority Interest in a Large Personal Services Firm”
View / Download May 2017 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

March 2017: Value to the Owner Cuts Both Ways

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

It was recently asserted in a case that if a business could be sold for more than it is worth to the owner, then the higher sale value should be used for divorce settlement purposes.

This case involved a minority shareholder who had no authority to sell the business, and the shareholders holding a majority interest had no intention of selling the company.

As recently summarized this column (October 2016), the Michigan Court of Appeals has ruled in a number of cases that if a business providing personal services is worth more to the owner than the price at which it could be sold, the value for divorce purposes is value to the owner – sometimes called “holder’s interest value” – unless there is reason to believe the enterprise will be sold.

But what about the reverse situation – the sale value – that is, fair market value (FMV) – is higher than the value to the owner?

Premise of Value to Owner

If there is no intent to sell or discontinue a business or professional practice, it should be valued for divorce based on its intrinsic value to the owner on a going concern basis. The financial benefits from that value are what have been conferred on the family while intact and will be conferred solely on the owner post-divorce.

Support – Kowalesky, 148 Mich App 151 (1986) and several other Court of Appeals (COA) cases (see October 2016 Tax Trends column).

Logic – If there is no intent to sell, under what rationale should any value other than the value based on current – financial benefits provided by the business be used in a divorce settlement?

No other value is relevant to this family or, hence, to this divorce.

Value to Owner Cuts Both Ways

Value to Owner Higher than FMV –
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Continued in PDF file below… “Value to the Owner Cuts Both Ways”
View / Download March 2017 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

January 2015 : Michigan Court of Appeals Rules on Trial Court’s Decision Concerning the Value of an Interest in an Inn in the Upper Peninsula: BAIRD-PETERSON V PETERSON, Mich App No. 319938 (10/16/14)

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

View Full PDF file

Facts

  • During the marriage, W invested $30,000 of marital funds in an LLC which was constructing the Mather Inn (Inn) in Marquette, Michigan, an endeavor initiated by W’s father.
  • The LLC agreement provided that a member’s interest would be lost–without compensation–incident to a member’s divorce.
  • Construction of the Inn “fell through” leaving debts reportedly exceeding the value of the property.
  • H claimed the business was worth $100,000.
  • The trial court ruled that the evidence did not support a value of $100,000 and, further, that W’s interest in the Inn had “no present value.”
  • The trial court also ruled, however, that if W ever realized a return on the parties’ $30,000 investment, she had to reimburse H his half of the investment
  • H appealed.

Court of Appeals Decision

In an unpublished opinion, the Court of Appeals (Court) upheld the trial court’s decision on the Inn.

The Court noted that the uncertainty of both (1) whether W’s interest had been lost and (2) whether outstanding debts exceeded value of the property supported the trial court’s decision.

Comment on the Case—Use of Value at Date of Divorce

As a rule, trial courts have a responsibility to determine value as close to date of divorce (DOD) as possible. Such value is used in the division of the marital estate.

One reason for the court’s responsibility to determine a value is the need for finality in divorce settlements. If a value were subject to change based on the occurrence or non-occurrence of future events, there could be a number of disadvantages:

  • Risk that post-divorce efforts are included in value divided between the parties. This generally relates to business enterprises in which a party has meaningful active involvement.
  • Need for the non-owner to “look over the shoulder” of the owner–not generally a welcome prospect after divorce.
  • Constrain the owner from taking certain actions, such as expanding.

In Peterson, the trial court found that the Inn had no value as of DOD. However, the trial court also ruled that if the Inn subsequently–that is, post-divorce–acquired value and, accordingly, W received a return on investment, such would be shared equally with H.

As indicated, value arising after DOD is not divided be- cause such value is typically attributable to events and/or efforts occurring after marriage.

Further, as ruled in Skelly v Skelly, 286 Mich App 578, 780 NW2d 368 (2009) and its progeny (Hoskins Mich App 309237 (5/28/13)–see October 2013 Tax Trends article), value attributable to events and/or efforts during marriage is not divisible if subject to a condition satisfied after marriage.
But, the objective of a divorce settlement is to achieve as equitable a result as possible. While some rules—including those established in case law—are necessary, so is the discretion to take into account the unique facts and circumstances of each case. In Peterson, although we cannot tell from the COA opinion, it is possible the trial court considered factors such as the following:

  • The Mather Inn LLC was owned by W and her father–a family LLC. The provision regarding losing one’s interest in the event of divorce is not found in most model commercial LLC agreements.
  • The investment of the $30,000 and signing the LLC agreement may have occurred a relatively short time before W filed for divorce.
  • The investment was in real estate which, in general, was recovering value lost in the recession as of the July 2013 divorce trial.

These are the type of factors a family court should have the discretion to consider in fashioning a fair settlement. In Peterson, the trial court did not assign any value to the Inn for the division of the estate, but did, evidently, believe that fairness compels H to receive half a return on W’s investment of marital funds should she ultimately receive same.

While finality is a laudable goal in divorce settlements, now and then–particularly in long term marriages–equity will not be achieved without a provision for sharing presently undeterminable value attributable in considerable part to years of marriage.

Example: A formula for dividing incentive compensation received for a set number of post-divorce years by an executive whose long, successful career overlapped the years of a long term marriage.

Though not allowed under Skelly, counsel are certainly free to include such a provision in a divorce settlement where compelled by fairness.

View full PDF file below… “Michigan Court of Appeals Rules on Trial Court’s Decision Concerning the Value of an Interest in an Inn in the Upper Peninsula: BAIRD-PETERSON V PETERSON, Mich App No. 319938 (10/16/14)”
View / Download January 2015 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section

December 2014 : Michigan Court of Appeals Rules on Availability for Support of (1) Undistributed S Corporation Earnings and (2) S Corp Distributions to Cover Taxes on Undistributed “Pass Through” Income: DIEZ V. DAVEY, Mich App No. 318910 (10/23/14)

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

Facts

  • The case, involving unmarried parents (Dad and Mom) of three children, was focused on child support, custody, and parenting time.
  • Dad is the sole owner of SGC, a manufacturer of equipment used in the aerospace industry.
  • SGC is operated as an S Corporation for federal tax purposes – that is, its income is “passed through” and taxed to Dad individually, whether actually distributed to him or not.
  • The Friend of the Court (FOC) conducted an evidentiary hearing and made a recommendation based on testimony of Mom’s CPA expert regarding Dad’s “money … available for support.”
  • Included in the FOC’s determination of Dad’s funds available for support were:
    • His W-2 income;
    • Various perks paid by SGC on his behalf;
    • All distributions he received from SGC, some of which were, evidently, made to provide Dad funds to pay the tax on undistributed SGC income; and
    • SGC’s “excess working capital” – that is, funds retained by SGC in excess of what the company needed to operate the business. The excess working capital was determined by application of (1) a formula used in some federal tax cases and (2) the CPA’s judgment.
  • The trial court adopted the FOC’s recommendation.
  • Dad appealed objecting, in pertinent part, to the inclusion of funds he allegedly had available for support as (1) excess working capital and (2) SGC distributions to pay tax on undistributed income, for the following reasons:
    1. Excess Working Capital – SGC was “capital intensive” and had to regularly purchase new equipment to remain competitive. Historically, such purchases were made with cash retained by the company. The amount of cash maintained by SGC was approximately the same year to year. Thus, the so-called excess working capital in fact consisted of funds that would similarly be used to acquire new equipment, continuing a long established SGC operating practice.
    2. Distributions to Pay Tax on “Pass-Through,” Undistributed Income—Distributions to pay tax on SGC income taxable to—but not received by—Dad were simply not funds available to him for support. Since the money was paid to federal and state tax authorities, it clearly was not “available” to him.

Court of Appeals Decision

In a published split opinion, the Court of Appeals (Court) agreed with Dad on the two issues noted above.

Excess Working Capital

The Court referenced the Michigan Child Support For- mula Manual (MCSFM) in which it is stated that “income (or losses) from a corporation should be carefully examined to determine the extent to which they were historically passed on to the parent.” (Emphasis added.)
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Continued in PDF file below… “Michigan Court of Appeals Rules on Availability for Support of (1) Undistributed S Corporation Earnings and (2) S Corp Distributions to Cover Taxes on Undistributed “Pass Through” Income: DIEZ V. DAVEY, Mich App No. 318910 (10/23/14)”
View / Download December 2014 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section