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%.
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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)

October 2016 : Revisiting Holder’s Interest Value – or Value to the Owner

Michigan Family Law Journal : TAX TRENDS AND DEVELOPMENTS Feature

by Joseph W. Cunningham, JD, CPA

Excerpt:

Of late, the holder’s interest standard – or measure – of value for appraising professional and commercial enterprises for divorce has been subject to criticism. The following addresses issues raised.

Background

Holder’s Interest Value—“Holder’s interest” value – also referred to as investment value to the owner – of a business appraised for divorce settlement purposes is essentially the value to the current owner based on financial benefits consistently received from the business, unless there is reason to believe the business will soon be sold or discontinued.

The underpinning is that financial benefits provided by the company are often the product of contributions by both spouses during marriage such that both should share in that value in a divorce settlement.

If that value is not transferable in a sale – such as a surgeon’s referral sources or a widget maker’s personal relation- ship with a valuable customer – it will only be reflected in the business value if it is assumed the current owner will continue the enterprise after the divorce.

Fair Market Value—Holder’s interest value is distinguished from the most commonly known standard/measure of value – fair market value (FMV) – defined as the price at which a business would sell between a willing buyer and a willing seller, both well informed and acting at arm’s length, and neither acting under duress.

The principal difference is that holder’s interest value is premised on the current owner retaining the business post- divorce, whereas FMV is premised on a hypothetical sale to a third party.

In determining FMV of a non-marketable closely-held business, a lack of marketability discount, typically in the 25%-35% range, is deducted from the calculated value – that is, between 1/4 and 1/3 of the total value is eliminated based on the assumption of a hypothetical sale. Aside from this significant discount, valuable but non-transferable attributes of the enterprise – such as noted above – will not be captured in the hypothetical sale value.

Premise of Holder’s Interest Value—Jay Fishman, a nationally renowned business valuation expert, at an American Academy of Matrimonial Lawyers 2006 seminar, presented the following quote from the California appellate court in its landmark Golden v. Golden opinion in support of value to the owner:

“… in a matrimonial matter, the practice of the sole practitioner husband will continue, with the same intangible value as it had during the marriage. Under the principles of community property law, the wife by virtue of her position of wife, made to that value the same contribution as does a wife to any of the husband’s earnings and accumulations during marriage. She is as much entitled to be recompensed for that contribution as if it were represented by the increased value of stock in a family business.”

In this regard, there is no substantive difference between community property law and Michigan’s equitable distribution statute concerning contribution of the non-business owner spouse.

Michigan Court of Appeals Holder’s Interest Decisions

—As summarized at the end of this article, the Michigan Court of Appeals has consistently approved use of holder’s interest value where there is no indication that the owner will not continue to operate the enterprise post-divorce.
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Continued in PDF file below… “Revisiting Holder’s Interest Value – or Value to the Owner”
View / Download October 2016 Article – PDF File

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