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%.
……

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