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Contents
Quick Links to SC&H Group, LLC 2009 MSBA Conference We were excited to see everyone at the 2009 Annual MSBA Conference in Ocean City. If you didn't get a chance to meet us in person, please give us a call. We would be happy to discuss any valuation issues that your clients are contemplating. Congratulations to Scott Wilson from Miles & Stockbridge who was the winner of our $100 American Express Gift Certificate drawing. Valuation and Estate Planning in the Current Environment The challenging economic environment has negatively affected many owners of privately-held businesses over the last 12 months. However, it has also created a unique estate planning opportunity for business owners who may be subject to estate taxes in the future. Due to these economic conditions, the values of many privately-held businesses and other assets have declined significantly due to:
As a result of these temporary declines in the value, business owners can use a variety of techniques to pass stock and other income producing assets to their heirs at a fraction of the long term value of those assets. In combination with the observed declines in the value of many assets, the low interest rate environment further contributes to the attractiveness of certain estate planning vehicles such as:
Our experienced valuation and estate planning experts are available to discuss these opportunities with you and guide you through the process of setting up estate plans and properly valuing interests for estate planning purposes. For more information about our Business Valuation practice, email BVLS@SCandH.com or call (410) 403-1500 | (800) 832-3008.
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Valuations Insights, Third Quarter, 2009 Divorce Court Favors 'Minimal Use' of Discounts in FMV Drumheller v. Drumheller, 2009 WL 565020 (Vt.) March 6, 2009 The two major disputes in the Drumhelle's divorce focused on valuation. The first related to the husband's 10% interest as CEO of a large printing company, which employed some 250 people. Also at issue was his one-third interest in the real estate partnership that owned the company's land and building. At trial, each party presented "highly qualified and experienced" appraisers, both with extensive backgrounds in business valuation--one with particular experience with the husband's company. The appellate court opinion does not provide much detail concerning the technical aspects of the valuations, but it does cite some interesting comments from the trial court on the experts' general methodologies, their indicia of credibility, and their application of discounts. The experts were not too far apart. In valuing the printing company, both of the parties' experts applied the three traditional approaches (income, asset, and market). In fact, the experts agreed that under the income approach, the company was worth between $7 million and $7.5 million. Notably, they also agreed that this value was too low, given the company's before-tax profits in each of the five years preceding the valuation. As a result, the wife's expert considered a net asset valuation, aggregating the company's cash and cash equivalents with the book value of its equipment and then subtracting liabilities. The trial court did not find the net asset approach "helpful" in this case, explaining that "[t]he trouble with the net asset value is that it depends on tax depreciation schedules [that] have little relation to the market value of the equipment and other assets." In addition, measures that depend on book value are "inherently unreliable," it said, "unless the book values are shown to be equal to actual market value for the assets in question." The wife's expert also used a guideline public company (market) approach, calculating a straight average of the comparables, irrespective of size. Using the same pool of comparables (five to six publicly traded companies), the husband put greater weight on the smaller ones. Overall, the court did not find the market approach much help, either. The pool of comparables was too small and the comparables too large. "By analogy, with enough adjustments for size and location, it is possible to compare a country cottage with Buckingham Palace," the court said,"but the integrity of the exercise suffers as the differences between the two properties widen." The income capitalization approach appeared to be the "most accurate way to measure the value" of the husband's company. The court also found the husband's expert more credible, not only because he focused on the income approach but also because he had valued the printing company for twenty years, for purposes of its employee stock ownership plan (ESOP). Also bolstering his testimony was this expert's "minimal use" of minority and liquidity discounts. Once again, the appellate court opinion does not provide the precise percentages that each expert used, but it does note the trial court's observation that in general, "the use of higher discount figures tends to push the appraisal values towards the realm of theory and away from actual life experience." The wife appealed the valuation of the printing company. She essentially raised the same arguments that she made at trial advocating the credibility of her expert and his opinions over the husband's. The appellate court rejected her arguments as "out of place" on appeal and affirmed the trial court’s valuation of the printing company. Fair market valuation requires certain 'fictions.' At trial, both parties presented additional experts to value the husband's 33% interest in the real estate partnership that owned the land and the large building in which the printing company had leased space for many years. The husband's expert did not consider the rent that the printing company actually paid the partnership, because it was not negotiated in an arm's length transaction and was higher than market values. In contrast, the wife's expert relied on the actual lease terms in calculating income streams for the property, including the assumption that the printing company would rent for the next seven years (two years remaining on the lease plus a five-year renewal option). This time, the trial court found the wife’s expert more persuasive:
The court found no rule prohibiting it from relying on lease values not negotiated at arms' length. It adopted the $7.2 million value for the real estate partnership, as calculated by the wife's expert, and the husband appealed. The husband argued that as a matter of law and under the fair market value (FMV) standard, a court should have presumed a sale or transfer of the property without the printing company lease. The appellate court disagreed. "To refuse to consider the presence of the... lease would be to ignore the effect of prospective use on valuation." The lease represented a source of income for the partnership, "now and for some period in the future," it added, "whether or not it was negotiated at arm's length." The trial court also rejected the husband's proposed minority discounts to his one-third interest in the real estate partnership. There was no evidence that a sale of his interest was "in any way possible," especially given the husband's control of the only tenant (the printing company) as its CEO. A nod to fair value standard. On review, the appellate court noted that the lower court considered expert evidence and gave credible reasons for rejecting discounts. Moreover, "[r]educing the value of the partnership interest, while husband received full income from the partnership based on full valuation, would be unfair to wife," the court held, citing Brown v. Brown, the 2002 New Jersey Supreme Court decision that is often cited for applying the fair value standard in divorce. "We conclude that the decision to disallow the minority discount in this case was within the family court's discretion." |
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